Retirement is a milestone many of us look forward to—a time to enjoy the fruits of your labor and spend more time on the things that matter most. However, the dream of a carefree retirement can quickly turn into a nightmare if you run out of money too soon.
Clients and prospects frequently ask me, "How long will my retirement savings last?" It's a concern that many investors have as they approach retirement and one that requires careful planning and consideration of multiple factors.
To address this question and provide investors with financial peace of mind that they won't outlive their retirement savings, we need to start with understanding the basics.
Understanding the Basics
Before diving into calculations and strategies for determining how long your retirement savings will last, it’s important to understand the fundamental components that affect the duration of your retirement savings, including:
Retirement Age and Life Expectancy: The age at which you retire and your expected lifespan are crucial. The earlier you retire, the longer your savings need to last. Advances in healthcare mean people are living longer, so it’s prudent to plan for a retirement that could last 30 years or more.
Retirement Savings: Also referred to as cumulative savings, this is the total amount you will have saved by the time you retire. This includes your 401(k), IRA, pensions, savings accounts, and other investments.
Withdrawal Rate: The percentage of your savings you withdraw annually to cover your living expenses.
Investment Returns: The annual return on your investments. This can significantly impact how long your savings last.
Inflation: The rate at which the cost of living increases. Inflation reduces the purchasing power of your money over time.
Expenses: Your annual expenses during retirement. This includes housing, healthcare, food, travel, and other personal spending.
Taxes: It's not about what you earn on your retirement savings but rather what you keep after taxes.
Calculating How Long Your Savings Will Last
One of the most popular methods for estimating the longevity of retirement savings is the 4% Rule. This rule suggests that if you withdraw 4% of your retirement savings in the first year and adjust this amount for inflation in subsequent years, your savings should last for about 30 years.
However, the 4% Rule uses certain assumptions that may not fit everyone's financial situation, one of which is maintaining a portfolio of 50% stocks and 50% bonds, an allocation that may not be suited for every investor.
Let's also not forget that there are other spending strategies to consider in retirement, a topic I discuss in further detail here.
In addition to analyzing spending strategies, you'll also want to account for other variables, including your projected rate of return on your investments, risk and volatility in the market, cumulative savings, annual and monthly spending amounts, taxes, and inflation.
To provide a more personalized estimate of how long your retirement savings will last, consider these steps:
1. Determine Your Annual Expenses
Calculate your expected annual expenses in retirement and be as thorough and realistic as possible. Consider housing, food, utilities, healthcare, travel, and leisure activities, and don’t forget taxes and unexpected expenses.
When in doubt, calculate what you spend annually today and use that figure for retirement. Here's a simple formula to determine current annual spend: Gross income - savings - mortgage payments - taxes = annual spend.
Example: annual household income is $250,000, you and your spouse each max out your pre-tax 401(k) plans, have a mortgage of $3,000/mo that will be paid off at retirement, and pay 30% in taxes. If that's the case, your annual spend would be roughly $100,000 ($250,000 - $61,000 401(k) savings - $36,000 in mortgage payments - $57,000 in taxes).
2. Estimate Your Lifetime Income Sources, Excluding Investments
Add up all sources of income you expect to receive during retirement excluding income from your cumulative savings (i.e. interest, dividend income, etc.). Lifetime income may include Social Security benefits, pensions, annuities, and part-time work.
Let's suppose your total other lifetime income sources equal $50,000.
3. Calculate the Gap
Next, subtract your annual expenses from your retirement income to determine how much you’ll need to withdraw from your savings each year. Using the previous examples:
Annual Lifetime Income: $50,000
Annual Expenses: $100,000
Annual Withdrawal Needed: $50,000 - $100,000 = -$50,000
If the result is a negative amount, it indicates a withdrawal from your savings is necessary.
4. Add Up Your Savings, Retirement and Investment Accounts
Now it's time to take an inventory of all of your savings and investment accounts to determine how long your retirement savings will last.
In continuing with this example, we'll assume $1.2 million in total retirement savings.
5. Determine a Projected Annual Rate of Return
With two of the primary retirement savings inputs now determined (distribution amount and total savings), you'll then want to project long-term average return assumptions to be used in retirement.
For context, a 60/40 portfolio of stocks and bonds, widely used by many investment companies and financial institutions as a balanced risk benchmark for investors in retirement, has returned, on average, 8% per year since 1976.
6. Use a Retirement Calculator
Finally, you'll want to input, at a minimum, the following data (derived from the examples above) into a retirement calculator (Google "free retirement calculators and choose one):
👉 Note that inflation can erode your purchasing power over time, so it’s critical to account for the expected inflation rate. If inflation averages 2–3% per year, your expenses will increase, necessitating higher periodic distributions.
See the results below from a free retirement calculator I used on Nerdwallet:
In this example, the retirement calculator generated favorable results, meaning your money should last well into your mid-90's.
However, not all financial calculators are created equal, and results can vary widely.
For a more sophisticated analysis, consider using Monte Carlo simulations. These simulations run thousands of scenarios with different market conditions to estimate the probability that your savings will last and the anticipated future values of your investments.
Monte Carlo accounts for the variability in investment returns and can give you a better sense of your plan’s robustness. Additionally, understanding the average annual compounded rate of return, including the reinvestment of dividends, can help illustrate the variability and potential growth of your investments over time.
Strategies to Extend Your Retirement Savings
Should your retirement results not be as favorable, here are some strategies to help make your savings last longer in retirement:
Adjust Your Withdrawal Strategy: As noted above, there are other spending strategies to consider, such as the Spending Smile (inflation-adjusted and declines by age), Floor Ceiling (based on investment performance), or Ratcheting Rule (performance-based with parameters).
Diversify Your Investments: A well-diversified portfolio can help manage risk and improve returns. Consider a mix of stocks, bonds, investment funds (i.e. ETFs), and other assets tailored to your risk tolerance and retirement horizon. Savings accounts at financial institutions may offer low returns but also carry significantly lower risk of loss of principal balances compared to investments that pay higher rates of return, which are generally subject to higher risk and volatility.
Delay Retirement: Working a few more years can boost your savings and reduce the number of years you’ll need to rely on them. Additionally, delaying Social Security benefits increases your monthly benefit.
Reduce Expenses: Cutting unnecessary expenses will help minimize cash flow shortages. This might include downsizing your home, reducing travel, or finding more cost-effective ways to enjoy your hobbies.
Consider Part-Time Work: Part-time work or a side hustle can supplement your income and reduce the amount you need to withdraw from your savings. I discuss passive income ideas for retirement in further detail here.
Monitoring and Adjusting Your Plan
Regularly review your retirement plan and adjust as needed. Changes in the economy, market conditions, the tax rate, your retirement date, and lifestyle can all impact your savings.
If you need help with your retirement plan or just want a second opinion, seek personalized advice from qualified professionals specializing in working with retirees. An annual check-up with a financial advisor can help you stay on track and make necessary adjustments.
You also want to be mindful of the sales charges, expenses, and other fees that your advisor or financial institution may charge, as these can affect your overall returns. Additionally, keep a close eye on your tax rate in retirement and seek tax advice early and often.
Conclusion
The question of "how long will my retirement savings last" is complex and influenced by numerous variables. By understanding your expenses, sources of income, withdrawal rate, and the impact of inflation, you can create a robust plan to ensure your savings last throughout your retirement. Utilizing tools like the 4% rule, Monte Carlo simulations, and adjusting strategies as needed will further strengthen your financial security.
Planning for retirement is not a one-time task but an ongoing process. Stay informed, remain flexible, and seek professional advice to navigate the uncertainties of retirement planning. With careful planning and prudent management, you can enjoy a financially secure and fulfilling retirement.
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