From August 6, 2009
One of the toughest decisions you'll have to make when you retire is how much to withdraw from your retirement assets on an annual basis. Take too much out and you may spend your later retirement years relying on the help of relatives or living a much lower lifestyle.
Your withdrawal amount can be calculated based on your life expectancy, your expected long-term rate of return, the expected inflation rate, and how much principal you want remaining at the end of your life. Guess wrong on any of those variable and you run the risk of depleting your assets too soon. But your life expectancy, rate of return, and inflation are difficult to predict over such a long time period. Keep these points in mind when making your calculations:
-
Your
life expectancy.
While it
is easy enough to find out
your actuarial life
expectancy, those life
expectancies are only
averages. Many people live
longer than those tables
indicate. How long close
relatives have lived and how
healthy you are can help you
gauge your life expectancy.
Just to be safe, you might
want to add five or 10 years
to your life expectancy.
After all, you wouldn't want
to run out of money at age
75 or 80, when you might not
be able to return to work.
-
Your
rate of return.
Expected rates of return are
often derived from
historical rates of return
and your current investment
allocation. Historical rates
of return are an average of
returns over a period of
time. Returns may be better
than that in some years and
worse than that in other
years. Even if you get the
average return right, the
pattern of those returns can
have a dramatic impact on
your portfolio. For
instance, individuals who
retired at the beginning of
2000 with most of their
portfolio in stocks may have
difficulty overcoming those
declines.
- Expected inflation. While inflation has been relatively tame recently, that has not always been the case. Over the past 30 years, inflation has averaged 5 percent (Source: Bureau of Labor Statistics). Inflation can have a dramatic effect on the purchasing power of your investments. For instance, at 2.5 percent inflation, $1 is worth 78 cents after 10 years, 61 cents after 20 years, and 48 cents after 30 years.
So what can you do to help ensure that you don't run out of retirement assets? Consider these tips:
-
Use
conservative estimates when
making your withdrawal
calculations.
Add a few years to your life
expectancy, reduce your
expected return by a couple
percent, and increase your
expectations for inflation.
While that will result in
lower withdrawal amounts, it
will also help ensure that
your funds last longer. Take
a careful look at any answer
that indicates you can take
much more than 3 percent to
4 percent of your balance
out each year. Several
studies have indicated that
that is a reasonable amount
to withdraw if you need your
funds to last for several
decades. That doesn't mean
you can't take more out, but
you should be very confident
of your assumptions before
doing so.
-
Review
your calculations every
couple of years.
This is
especially important during
the early years of your
retirement. If you find that
you're depleting your assets
too rapidly, you may be able
to go back to work on at
least a part-time basis. If
you find out late in life
that you're running out of
assets, you may not have the
option of going back to
work.
- Consider placing three to five years of living expenses in cash or fixed-income investments. That way, if you encounter a severe bear market, you won't have to touch your stock investments for at least three to five years, giving them time to recover.
