Have you ever asked yourself how long will my money last?
If you've come to the conclusion that Social Security alone will not provide you with the retirement you're looking for. You need to take action.
You might be want to retire by age 40, or you might expect to work until the traditional retirement age. If you're lucky enough to have a pension, you'll need to remember that these retirement plans usually don't start paying out until at least age 55. Regardless of when you're looking to retire, you'll want to answer an important question. How long will my money last?
With a few simple money planning steps, calculations, and a bit of effort you can ensure you won't outlive your money.
Work-Based Retirement Plans
It's more likely that you have a 401k or similar plan for building up your nest egg supplied by your employer. This should be thought of as a necessity for supplementing any Social Security benefits you might draw. If you're looking to retire early, you might wonder how you can survive if you can't access your tax-deferred funds until you hit age 59 1/2. Under certain circumstances, there is the possibility of taking payments via Rule 72(t).
This requires that you calculate substantially equal periodic payments and take them every year until your traditional retirement age to avoid incurring a penalty. However, most people who want to retire early will want to build up a stash of taxable investments outside of their work-based plans. The funds in taxable accounts can provide a bridge to the point that you can start withdrawals from your 401k.
Individual Retirement Accounts
Even if you don't have access to a 401(k) or a 403(b), you can still save in an IRA. The max is only $6,000 per year, which is well short of the $19,500 you can save in a 401(k). However, given enough time, even a relatively small amount can grow to a sizable stash that can fund your retirement. Keep in mind that you can still save in an individual retirement account even if you have access to a pension or a 401(k).
IRAs can provide you with more control over your investments. Rather than just investing in stocks or bonds, you can invest in real estate or precious metals through an IRA. Just keep in mind that you'll owe taxes on your withdrawals with a traditional IRA. With a Roth version, you'll pay taxes in the current year and then owe nothing when you make withdrawals as long as you wait to access it until 59 1/2 years of age.
What Are Your Living Expenses?
When you're looking at retiring and trying to figure out how long your money is going to last, you'll need to look carefully at your expenses. How much do you spend in an average year? Thinking in terms of the average can help you smooth out the bumps that can come from needing to replace a roof one year and skipping a costly vacation the next.
Once you have your average expenses figured out, you can then go about attempting to meet them with your retirement funds and taxable investments. If you've reached at least age 62, you can also take any Social Security benefits you're drawing into account. Just remember that filing at 62 will cut your Social Security income for life.
What Is Your Savings Rate?
The popular personal finance blogger Mr. Money Mustache has a retirement calculator on his post that details “The Shockingly Simple Math Behind Early Retirement.” He argues that your savings rate is the most important number you'll need to pay attention to when looking to retire early. If you can save 90% of your income, you could theoretically stop working for money after working for two or three years.
On the other hand, if you save only 5% of your income every year, you'll need to work for about 66 years to replace your income and take care of your expenses. Your savings rate is key to retiring early. Additionally, a high level of savings usually comes with a low level of spending, and those in this situation should be able to retire more modestly at a relatively early age.
Where Should You Invest For Retirement?
If you're looking to become an early retiree, you'll want to invest your money for growth. A CD or a money market account will not meet this need. Your money will basically tread water when it comes to purchasing power. You'll need to put at least some of your money into the stock market. A Vanguard index fund will come with low management fees and generally track the overall stock market.
Mutual funds allow you to purchase a basket of stocks in one simple move. These investments will help you diversify your investments in a way that buying stock in one or two companies will not. You might also want to invest in a bond fund if you fear market volatility. You won't be as likely to see massive growth, but the drops in your account value during a recession should be lower.
Another option for a retirement savings plan is a target-date fund that adjusts your risk profile as you get older. These funds are set to the retirement target date you choose. If you're 30 and looking to retire at age 60, you'd likely want to choose a fund that's focused upon the year 2050 or 2055. If you're 50, you'll probably want a 2030 fund. The older you get, the more cash and bonds the funds will hold. The younger you are, the more the fund will invest in stocks. This is intended to cut your risk as you get closer to retirement although this will likely come at the expense of a higher rate of return.
How Much Do You Need To Retire At 40, 50, or 60?
If you go back to the initial question of how long will my money last, you'll need to take your life expectancy into account. Your family might tend to die early. You'll want to take that into account, and you might need less money to retire. The average life expectancy in the United States is between 75 and 80.
Therefore, if you're retiring at 40, your money will likely need to last for 35 or 40 years. Most financial advisors will tell you you need $5 million to retire at this age. That may or may not be the case. The amount of money you'll need is based upon the following data:
- Your income
- Your savings rate
- Your average expenses
A famous study called the Trinity Study concluded that a retirement fund that included 50% stocks and 50% bonds could last at least 30 years as long as you withdraw no more than 4% of the account value each year. This 4% number is very important in retirement planning. If you could save up a $1 million account balance in a savings account, it would last for 25 years if you took out 4% annually.
With the growth that can come from stocks and bonds which is typically more than inflation, the money should last longer as long as you adjust your 4% withdrawals. If the market is down in a given year, spend less. If it's up, you'll see growth if you keep your spending indexed to inflation.
The earlier you're looking to retire, you might want to dial back your withdrawal rate. If your spending is $50,000 and you want to take out no more than 3%, you'll want a nest egg of around $1.5 million. Basically, you'll want to save up between 25 and 30 times your annual expenses.
You can always make a little money from part-time work or a side hustle, and you'll eventually be able to access any pension or Social Security income to which you're entitled. This could extend the ability of your nest egg to sustain you even longer. If you're curious about how to stretch your retirement nest egg and manage withdrawals, it's a good idea to check with an advisor or play around with a retirement calculator. These can help you with your retirement planning so that you don't run out of money.
Brian is a dad, husband, and an IT professional by trade. A Personal Finance Blogger since 2013 who, with his family, has successfully paid off over $100K worth of consumer debt. Now that Brian is debt-free, his mission is to help his three children prepare for their financial lives and educate others to achieved financial success. He blogs at Debt Discipline.