As you near retirement, you might look back and think that saving for this next stage of life was the easy part.
During your working years, the big decisions were how much to save and where to invest.
But now it’s time to switch gears. Instead of accumulating assets, you must figure out how to turn your nest egg into an income stream to last the rest of your life.
The best place to begin is to get a handle on what your annual expenses will be in retirement by creating a retirement budget.
Take a look at what you’ve spent in the past year. Then adjust those expenses for what might change in retirement. For instance, you won’t be commuting to work anymore, but you might be traveling to more far-flung destinations.
And don’t overlook health care costs, especially if you plan to retire before you’re eligible for Medicare.
Once you’ve nailed down your anticipated expenses, subtract all your expected guaranteed sources of income, such as a pension, annuity and Social Security.
The result is how much you will need to withdraw from your portfolio annually to maintain your lifestyle in retirement.
But how do you know if you will be withdrawing money too quickly from your nest egg and might deplete it?
One popular guideline has been the 4% rule, which was designed as a safe withdrawal rate for a 30-year retirement that may include bear markets and periods of high inflation. It assumes half of your retirement portfolio is in stocks and the other half is in bonds and cash.
Under this rule, retirees draw 4% from their portfolio in the first year of retirement. Then they adjust the dollar amount annually by the previous year’s rate of inflation.
So with a $1 million portfolio, your withdrawal in your first year of retirement would be $40,000. If inflation that year goes up 3%, the next year’s withdrawal would be $41,200. And so on.
The 4% rule is a good starting point but may need some fine-tuning to fit your own situation, says Maria Bruno with Vanguard.
“Are you retiring at a younger age? If so, you might need a lower withdrawal rate.” You may also need to withdraw your money more slowly if you are investing more conservatively, she adds.