Do you have enough for retirement? The amount of money that you save is important, but not the only thing that matters.
Studies have shown that factors like how you're invested and how much money you take out each year also affect how long your savings will last. Here's by how much.
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The Trinity Study
Performed in 1998, the Trinity Study popularized the idea of a low withdrawal rate. But it also found that a shorter time spent in retirement and a more aggressive portfolio could help you preserve your assets as a retiree. A more conservative rate of return, a high withdrawal rate, and a longer period of time could increase your probability of running out of money.
For example, if you planned for spending 20 years in retirement, the study found that there was a probability of at least 76% that a 4% or 5% withdrawal rate could keep you from running out of money -- even if you had a conservative portfolio of 100% bonds. If you increased your stock exposure to at least 50%, you could potentially take out 6% of your account value each year for 20 years and still have a 79% probability of outliving your assets.
If you instead planned for 30 years in retirement, a lower withdrawal rate of 3% or 4% of your portfolio value would be required. Your odds would be lowered to a 41% chance of having enough money with an all-bond portfolio and a 4% withdrawal rate but 82% if you kept it at 3%. Your probability would've increased to 87% if you added 25% stocks to your investment mix and took out 4% each year from your accounts. And even with a more aggressive portfolio, taking 5% from your accounts each year would've given you a 77% chance of outlasting your money.
Knowing this information can help you maximize your retirement savings in these three ways.
20 Years-Chance of Not Running Out of Money
| Withdrawal Rate | 100% Bonds | 25% Stocks/75% Bonds | 50% Stocks/50% Bonds | 75% Stocks/25% Bonds | 100% Stocks |
|---|---|---|---|---|---|
| 3% | 100% | 100% | 100% | 100% | 100% |
| 4% | 94% | 100% | 100% | 100% | 100% |
| 5% | 76% | 94% | 99% | 94% | 91% |
| 6% | 39% | 63% | 79% | 80% | 81% |
| 7% | 27% | 46% | 61% | 69% | 71% |
Data source: Trinity Study.
30 Years-Chance of Not Running Out of Money
| Withdrawal Rate | 100% Bonds | 25% Stock/75% Bonds | 50% Stocks/50% Bonds | 75% Stocks/25% Bonds | 100% Stocks |
|---|---|---|---|---|---|
| 3% | 82% | 100% | 100% | 100% | 100% |
| 4% | 41% | 87% | 100% | 98% | 93% |
| 5% | 18% | 42% | 68% | 77% | 77% |
Data source: Trinity Study.
What is your time horizon?
Thinking about your life expectancy can be tough, but it's a vital part of retirement planning. And how long you need your money for could make a huge difference in the amount that you can take out each year. There is no way that you can perfectly predict how long you will live in retirement, but your gender and current age will play a role.
If you have a family history of longevity, you may want to assume you will too and take a more conservative withdrawal rate. Your time horizon can also be determined by when you retire. And even if you have a long life expectancy, retiring later can help shorten the number of years you will need your money for.
How much are your expenses?
You may intend on keeping your withdrawal rates small. But if your expenses are out of control, you could end up taking extra money from your retirement accounts each year. Figuring out what your bills will be before you retire is a great way of making sure this doesn't happen.
If you determine that you will need $50,000 each year in retirement income and Social Security will provide you with $20,000, you will need $28,000 each year from your retirement accounts. If you have $500,000 saved, you would need a 5.6% withdrawal rate to reach that number, which might be too much. But you can potentially solve this problem by saving $200,000 more before you retire.
If that is impossible, you can reduce your expenses down to a more manageable withdrawal rate. Paying off bills like a mortgage or car note could help. If you can't do this, downgrading your home or figuring out discretionary expenses that could be eliminated are options.
How are you invested?
If you can stay invested after retirement, some of the market growth you experience can help offset your withdrawals. For example, if your accounts are sitting in cash and you start retirement off with $500,000, a 4% withdrawal of $20,000 in the first year would reduce your account to $480,000. In the next year, you would take 4% of your new value, or $19,200. Not only would your account value decrease each year, but the amount of money you can take will as well.
If instead, you took your withdrawal but then earned 7%, your account value would still be reduced to $480,000 immediately, but then grow to $513,600 by the end of the year. In year two, you could give yourself a slight raise by taking 4% of your new account value, or $20,544. Rates of return aren't always positive, so there will be years when you have less than you did in the previous year. But if over the long term, the stock market trajectory is up, you should also see your retirement income increase over time.
You may be worried that you haven't saved enough. But if the lifestyle you can afford differs from the lifestyle you need, you should be concerned with how much you're spending. Including your withdrawal rate considerations in your retirement planning process can help ensure that these numbers match as much as possible.
