Unless you opt to continue working in retirement, you're going to be living on a combination of Social Security and savings. Now the good news about Social Security is that it should pay you the same benefit for life, so you'll know how much income to expect. In fact, your monthly Social Security paychecks might increase over time as cost-of-living adjustments are applied year after year.
But still, those benefits might represent just a portion of your total retirement income. And the rest of your income might have to come from the money you've socked away in your 401(k) or IRA.
Now ideally, you'll enter retirement having amassed a fairly large chunk of money. But it's important to understand how much income your savings will allow for on a yearly basis. And there's one easy way to find out.
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Establish a smart withdrawal strategy from the start
Your goal in managing your nest egg should be to ensure that you're not depriving yourself of income, but also not depleting your savings prematurely. That can be a tough balance to strike.
That's why it pays to put thought into your savings withdrawal rate. Once you land on that number, you can determine how much income your savings will give you on a yearly basis.
So, let's say you're kicking off retirement with a nest egg worth $2 million. That's a lot of money. But you may want to play it safe and decide you'll only withdraw from that sum at a rate of 2% per year. That's a conservative withdrawal rate for retirement savings, but if you're retiring at a fairly young age and have a family history of longevity, it may be a good bet. And in that case, you'd be looking at an annual income of $40,000 from your savings.
On the other hand, you may decide to get a little more aggressive and withdraw from your savings at a rate of 4% per year. This could be a reasonable approach if you're retiring a bit later and don't necessarily expect to live longer than the average American. In that case, you're looking at a yearly income of $80,000.
Of course, these numbers don't account for Social Security. The point, however, is that it's important to establish them up front -- before you commit to different retirement expenses.
Let's say you're looking to buy a condo in a beach community that gives you access to great amenities as a retiree. Before you commit to the $500 monthly HOA fee that comes with it, not to mention a potential mortgage payment, you'll need to make sure all that fits into your budget. And you won't be able to answer that question until you've determined how much annual income you're actually in line for.
Prepare to be flexible
The withdrawal rate you start out with for your savings may not be the one you stick with. If you begin by withdrawing 4% of your savings early on in retirement and find that your investments aren't performing as well as expected, then you may need to adjust that rate downward. And on the flipside, you may decide to eventually move from a 2% withdrawal rate to 2.5% or 3%.
Either way, it's important to know what to expect from your savings before you start spending that money. So take the time to determine the best withdrawal rate, and if you're not confident making that call on your own, enlist the help of a financial advisor for their input.
