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Preserve Your Nest Egg

How long will your savings last?

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By Robert Brokamp

You've heard it all before: Don't go swimming for at least an hour after eating. Cross that bridge when you come to it. You'll be able to live on 70% to 80% of your current income in retirement.

Unfortunately, we're qualified to address only the last (though if you can cross a bridge before you've come to it, we'd like to see pictures).

There you sit with a finite pile of savings from which you will need to take all or most of the money to support your retirement spending. The accumulation phase of life (using all those retirement accounts you learned about from those Fools) are nearing an end. How much of that stash can you safely take each year to ensure it lasts your lifetime? Will you take the same amount annually? Or will you just buy all the cool toys and vacations you've always really wanted, and let your slightly older self deal with the fallout a few years later?

All of these questions boil down to one over-arching theme that we've thoughtfully put in bold-faced type below:

How long will your money last?
The "70% to 80%" rule of thumb is based on the assumption that many of your current expenses will go away in the golden years. For the most part, this is true. Once you kiss the boss goodbye, you'll no longer endure the following:

  • Work-related expenses, such as commuting costs, professional wardrobe upkeep, and cubicle decor
  • Social Security taxes (15.3% of income for the self-employed, 7.65% for the other-employed)
  • Contributions to retirement plans (it's time to stop the giving and start the taking)
  • Mortgage payments, if your house will be paid off by the time you retire.

There are two other ways your expenses might decline. First, retirees tend to downsize. With no need to keep the four-bedroom house now that the kids are grown, for example, some pensioners flee the big house for the Sag-A-Lot colony for mature nudists. Overall taxes might also decrease. Only a portion of Social Security benefits are taxable -- if at all -- and any income derived from long-term capital gains will be taxed more gently than ordinary income.

Some studies support the 70% to 80% rule. The 2001 RETIRE Project report, conducted by Georgia State University, found that retirees need 74% to 83% of their income to maintain the same lifestyle in retirement.

However, some require the same level of income in retirement they enjoyed while working. How? It comes down to this: If you're not making money, you're spending money. You have to fill the free time somehow. New hobbies, trips to Europe, and gas-guzzling RVs cost money. Many subscribers to our Rule Your Retirement newsletter have said they planned on spending less in retirement, only to find themselves shelling out even more, particularly in the early retirement years.

Another big expense is health care. A survey in the Journal of Gerontology (now that's fun readin'!) found that 61% of couples age 70 and older and 54% of single adults spent at least 10% of their retirement savings on health care. A startling 45% of couples lost more than half of their savings to medical bills. Medicare is not free (there are premiums and deductibles), and it doesn't cover everything (e.g., most long-term care).

The real price of leisure
So what will retirement cost you? To find out, let's pretend budget! By doing a little guesstimating now, you'll figure out how much you'll need in retirement -- and perhaps more importantly, how much you need to save today to get there.

If you're more than a decade from retirement, this exercise will take some high-level number-crunching. Here are some resources that can help you with the math, and perhaps some advice:

  • The Fool's retirement calculators: See how retirement will affect your expenses, whether you're saving enough, and what you can change.
  • To get an idea of how much you'll pay in taxes, complete a sample return -- if you use an online service or software to prepare your taxes, this won't seem so daunting.
  • The Motley Fool Rule Your Retirement service: Rule Your Retirement combines a monthly newsletter (featuring articles on assets allocation, wealth defense, and living the good life), a companion website (featuring more calculators and the "How to Plan the Perfect Retirement" online seminar), and active discussion boards where Fools are waiting to answer all your questions.

To put it in terms of that three-legged stool we referred to earlier, you'll need to find out how much you can expect from each leg. Here are some resources to help you:

  • Social Security: You should receive a statement from the Social Security Administration (SSA) every year, estimating your disability, survivors', and retirement benefits. The older you are, the more you can rely on those estimates. If you don't have the statement handy, visit the SSA's benefit calculators.
  • Pension: Contact the human resources folks at the office to find out how your pension benefits will be calculated, and how much you've accrued. Also, there's "What You Should Know About Your Retirement Plan," a publication of the Department of Labor (which oversees pensions and other benefits).
  • Savings: As the Violent Femmes sang, "Add it up" (though it's doubtful they were talking about retirement). Estimate the value of all your 401(k), IRA, and any other savings you won't touch until you retire.

Add up your projected annual Social Security benefit, projected annual pension benefit, and 4% of your nest egg, and you arrive at a rough estimate of what your retirement income is looking like. Why 4%? We recommend that Rule Your Retirement members can safely withdraw 4% from a properly diversified portfolio. The best research we've come across concludes the following:

  • A "safe" withdrawal rate ranges between 4% to 6% of a retiree's starting portfolio.
  • Withdrawal periods longer than 15 years dramatically reduced the probability of success at withdrawal rates exceeding 5%.
  • Bonds increase the success rate for lower to midlevel withdrawal rates, but most retirees would benefit with at least a 50% allocation to stocks.
  • Retirees who desire inflation-adjusted withdrawals must accept a substantially reduced withdrawal rate from the initial portfolio.

The accuracy of that approximation depends on your age. If you're 65, then that estimate is quite accurate; if you're 25, thankfully you have many decades to improve your lot.

Let us help you calculate what you can expect (and what you'll need!) when you retire. Take a free 30-day trial of our Rule Your Retirement service and start crunching a few key numbers.

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