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Most retirement planning conversations focus on how much you need to save for post-career life. But it’s equally important to think about how you will disperse that money once you retire — specifically, how much can you take from your savings each year to fund your new life?
I believe that question can often be answered using one of my favorite financial rules of thumb — the "1,000 Bucks a Month Rule," which says that for every $1,000 per month you want at your disposal in retirement, you need to have at least $240,000 saved.
Someone who has saved at that level and retires at a “typical age” of 65 to 66 should be able to annually withdraw approximately 5 percent of their investments during retirement, without running out of money (5 percent x $240,000 = $12,000 a year, or 1,000 bucks a month). Earlier retirees, those in their early 60s, and super early retirees in their 50s, should draw down their savings at a slower rate, 3 percent to 4 percent, to help ensure that their money lasts over that longer time horizon. Another long-standing financial planning rule coined by MIT graduate William Bengen says retirees who withdraw 4.1 percent of their initial retirement portfolio balance, then adjust higher each year for inflation, should see their money last 30 years.
Needless to say, there's great debate around this topic. Remember, using 5 percent is a rule of thumb, and you need to be flexible. In years when market returns and interest rates are in their historical range, a 5 percent withdrawal rate works well. But in years (or a stretch of years) when the market is in retreat, you may need to throttle back a bit on your withdrawals. I agree with Bengen's sentiment that, "I always warned people that the 4 percent rule is not a law of nature like Newton's laws of motion. It is entirely possible that at some time in the future there could be a worse case."
How does the rule apply to you? It takes a bit of planning and math to implement the 1,000 Bucks a Month Rule. First, you need to determine how much you need to save for retirement — how many multiples of $240,000. Decide what your post-career life will look like. Lots of travel? Starting a business? Helping the next generation of family get established? A mountain cabin?
Next, calculate the monthly expenses associated with your dream scenario. Then, subtract from those expenses your income from Social Security, as well what you expect to generate from pensions, a part-time retirement job, or rental income. The remainder is what you need from savings on a monthly basis. Multiply that by 12, and you have your annual shortfall. Now, multiply that number by 20, and you have a rough savings goal.
Example:
Projected monthly expenses: $6,000
Monthly Social Security benefit -$2,500
Monthly pay from retirement job -$500
Monthly rental payment from condo -$1,000
Monthly shortfall: $2,000
$2,000 x 12 = $24,000, your annual need
$24,000 x 20 = $480,000
And $480,000 is your minimum savings goal.
Remember mathematically, if you leave money under a mattress (at zero interest), a 5 percent rate of withdrawal will give 20 years of runway (with no inflation adjustments). Whether you have $240,000 or $2.4 million saved, 20 years is a good stretch of time. But we are living longer these days. And what if you want to leave something to your heirs? This is where income-investing comes into play.
Income-investing is a way to generate consistent cash flow from your investments. An income-focused portfolio generates revenue from dividend-paying stocks, interest on bonds, and distributions from other assets, such as real estate investment trusts and preferred stock.
If your investment portfolio is yielding 3 percent to 4 percent annually, and you get even 1 percent to 3 percent growth/appreciation, you stand a good chance that your money will last a lifetime.
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