How Much Money Do You Need To Retire?

This is a question I get asked frequently.  Up until now, I've never felt qualified to make a recommendation on this question.  Not because I didn't have an opinion (no one could ever accuse me of not having an opinion), but because I was having trouble conceiving of a coherent explanation.  Recently, a reader emailed me this very question and I proceeded to write her a very convoluted response (sorry Denise!)  It turns out, I've been making this much harder than it needs to be.

For the last 20 years, I have been playing with on-line retirement calculators, packaged retirement software, and even designed my own VERY complicated retirement spreadsheet.  All to come up with an answer that OTHERS HAVE ALREADY FIGURED OUT.  I didn't need to recreate the wheel here.

Jacob at Early Retirement Extreme recently posted two excellent posts on this topic.  One of his commenters, Dividend Growth Investor, recommended a great article about this very issue (Determining Withdrawal Rates Using Historical Data).

I was an Economics major in college, and followed that with a 22 year tax/finance career, so I found the article fascinating.  I understand, though, that most normal people won't, so let me give you the punch line:

1. Figure out how much your annual retirement expenses will be, and
2. Multiply this number by a number between 25 and 33, depending on your age (more on this below).  That's how much money you will need to have saved to have a worry-free retirement. 

According to this article, the historical averages for stocks, bonds, and inflation over the last 80 years were 10.3%, 5.1% and 3%, respectively.  But I am not really interested in what happened over 80 years; what we really need to know is what happens over 30, 40, or 50 years, specifically the years of our retirement.

The next best thing to a crystal ball is what author, William Bengen, achieved with in this article.  He studied each and every chunk of time within that 80-year time period to come up with some safe guidelines under which a retiree during ANY of the historical 30, 40, or 50 year periods would have weathered the storms successfully.  (And this period included some pretty serious storms, even the 1929 stock market crash.)  What he found:

• The "absolutely safe" initial withdrawal rate is 3%.  (The initial withdrawal "rate" is the percentage of your portfolio that you can take out the first year for living expenses.  Every year after that, you would take out that that dollar amount, increased for inflation.)  There was no historical 50-year period where you would have outlived your money using a 3% withdrawal rate.
• A 4% withdrawal rate could very likely carry you through 50 years.  Historically, there would have been no period where it would not have lasted at least 33 years. 

What does this mean to you?  How can you translate this into something simple for retirement planning:

• If you want to retire in your 40's (with potentially 50 retirement years out in front of you), you will be extremely safe if you have accumulated 33 times your annual expense budget. 
• If you want to retire in your 60's (with potentially 30-something years in your retirement), you will be extremely safe if you have accumulated 25 times your annual expense budget. 
• (For retirees in their 40's to 60's the extremely safe number is somewhere in between.) 

The even better news is that over most historical periods, the 4% rate (25 times your expenses) would have been safe enough, even for 50 years.  If you  are very young and you want to retire, you could always use this approach, and then, if you get into trouble, tighten your belt for a few years, or pick up a fun part-time job.  You have options that could put you right back on track.

All of this data is based on having a portfolio which includes at least 50% stocks (the rest in bonds).  If you have the stomach for it, 75% stocks works even better and doesn't subject you to that much more long-term risk.  History shows that any portfolio with less than 50% stocks would not have carried you through a long life in retirement. 

So, for those of you that have recently retired, and like me are getting the jitters from today's stock market, DON'T PANIC.  Do not, under any circumstances start selling off the stock portion of your portfolio!  According to the historical data, if you had done this in past market downturns, you would not have had enough money to get you through the rest of your life.  Those that kept a cool head, and those that even upped their stock holdings during those times are the ones that came out ahead.

Be sure to read:  The Scary Impact of Inflation on Your Retirement Budget

Related Posts:

Retirement Into a Down Market

Retirement Into a Down Market-Part II

Retirement and the "B" Word

 

Comments

[Shane]

Love your blog. Curious if you'd detail where you have saved money over the years. Not which stocks or funds, but more about how to save money strategically outside of tax-deferred vehicles like 401s and the like. Most tips seem to be about maxing those out but you're many years away from touching them and I would love to hear more about where you put money that you can access in the hear and now.

[Early Retirement Extreme]

Generally the same places as 401k and IRAs. Just don't tick the IRA/401k option on the application. Personally, I have a few mutual funds in taxable accounts (HSGFX and DODFX are my main positions). I got most other savings invested in 15 different stocks with an online broker (scottrade). My cash position is very small relatively speaking (probably around 5%).

[Rosie]

Great post! This is such a helpful expansion on the great discussion over at ERE. Thanks Syd!

[Retired Syd]

@Shane I agree with Jacob at ERE that I didn't really distinguish between my retirement accounts and those that were outside of retirement. I generally followed an overall allocation, without a whole lot of thought of which accounts to invest with before- or after- tax dollars. (Although, when I had many years to go before retirement, I generally held the bond portion in my retirement accounts so that the ordinary income (higher-tax rate income) was held in tax-deferred accounts.) As I got closer to retirement, I made sure I liquidated some mutual funds (non-retirement accounts) over those years, so that I would have 3 years' living expenses in cash when I retired.

[Sylvia B]

I'm one of those folks who is lucky enough to be retiring on a pension. I'm going to have 60% of my current income to live on. Thing is, lots of folks say that 60% will be more like 75% because I'll be paying less income tax (here in Canada, I'm in a 45% tax bracket ... if you're American, please don't gasp!) but nobody's really able to give me hard numbers so I'm still waiting to see what happens after I retire in October. I am worried a bit but I guess I'll have to figure it out when the time comes.

[HIB]

Great post! I am currently 30 and would like to retire by 40. I have a lot of work to do!
Thanks!
-HIB

[Retired Syd]

@HIB--thanks for stopping by!

[Dan]

Hey Syd,

Your neighbor from down the street. I've done similar calculations but have decided 2% or 2.5% withdrawal rate is more sustainable. (ie, multiple of 50 or 40)

One thing you didn't discuss is the amount of money left after you die -- $0, inflation adjusted starting amount, or something in between.

[Retired Syd]

Hey Dan from down the street! Well I'm assuming zero at the end (and hoping I've calculated the end pretty accurately!) But with two kids, you would probably want something to be left at the end, I suppose!

[Dividend Growth Investor]

The 4% solution is mainly for a 50/50 or 75/25 stock/bond portfolio allocation.

I am a bigger supporter of living off the cashflows from your portfolio. In the current market environment where most stocks yield 3% or more and you could find CD's yielding more than 5%, you could easily create an income stream of at least 4% annually that has a lower risk of decreasing.. Furthermore there is a high chance that your dividend income stream will increase over time, above the rate of inflation