What Does It Take to Retire Comfortably?
What's your number?
There are 10,000 people retiring in this country every day, nearly all of them without any specific, written plan to ensure their money outlasts them. And, of course, people are living longer than ever. With federal and most state budgets already severely strained – in some states dangerously so – and with the prospect of the Social Security trust funds nearing depletion (based on the current trajectory and absent any changes), public policy implications are daunting.
We don’t offer a policy prescription here, but we can at least help Coloradans become financially independent and self-reliant in retirement by framing the issue with some simple arithmetic and a very handy rule of thumb.
The framing question is: How much investment capital do you need on your retirement date so that, given some reasonable rate of withdrawal, you will have the income you need –on top of Social Security and any fixed pension benefit you may have – to live comfortably in your first year of retirement (in today’s dollars)?
In other words, what’s your number?
It turns out, there’s actually a pretty simple algorithm for figuring this out. As an illustration, let’s assume you plan to retire in 10 years, and the total after-tax income you’ll need each month in your first year of retirement is $10,000 in current dollars. (To account for taxation, you would need to gross up this number by your tax rate.)
Let’s further assume you have no corporate retirement plan or other sources of retirement income other than $2,000 of monthly Social Security, which we assume will be adjusted upward annually for inflation. So you’ll be looking to your investments to generate the remaining $8,000 (in current dollars) each month for that first year.
Note that your investments don’t have to yield $8,000 in interest or dividends. Instead, we’re calculating an amount you’d be comfortable withdrawing each month to support your lifestyle.
We also have to account for inflation, which we’ll assume to be 2.25 percent annually for the next 10 years until you retire. Thus, the $8,000 requirement in current dollars inflates to $10,000 in future dollars. So on an after-tax, inflation-adjusted basis, and as a supplement to Social Security, you’d need $10,000 per month, or $120,000 annually.
Now we’re going to make the critical assumption, which is that to try to keep your capital intact and even give it a chance to keep growing, you’ll want to withdraw no more than 4 percent per year.
The so-called “4 percent rule” is a guideline for determining the amount to withdraw from a retirement account each year. This rule seeks to provide a steady stream of funds to the retiree while maintaining an account balance that should last for approximately 30 years.
To determine the required capital sum for our example, we divide $120,000 by 4 percent [120,000 / .04], which is $3 million. That’s your number – the amount you would need to start with.
With $3 million in capital, in most cases, you should be able to withdraw 4 percent per year to cover your expenses without any major risk of exhausting your capital. Keep in mind this is a rule of thumb, not a guarantee – because the markets are unpredictable, there is no such thing as a perfectly safe withdrawal rate.