If you want a financially comfortable retirement with enough cash on hand, there are two basic steps you need to take.
First, save a lot while you are still working.
Second, withdraw the money in such a way that you will likely run out of money before you run out of life.
In a recent article, I described how to design a payout strategy that will keep your portfolio healthy when you've saved enough (but only enough) to meet your needs.
Read: A Solution to the Pension Crisis Exists – but only on paper
This means that you take out a fixed percentage of the portfolio value for the first year and then adjust upwards each year to take into account actual inflation.
If you retire with a portfolio that is at least 25 times the annual payout you need (in other words, with $ 1 million if you need $ 40,000 in the first year) you will You will most likely be successful.
This 4% payout rate is recommended by many financial planners and consultants. But if these withdrawals have to keep increasing with inflation, they don't leave much "scope" for bad times in the stock market.
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There is a better way. If you have saved more than enough To finance your first annual payment, you can set up what is known as a flexible distribution plan.
In this case, start by taking a percentage (say 4%) of your portfolio in the first year. The other 96% remains invested, and a year later you take out 4% of its then value.
In a 2020 article, I called this the ultimate age distribution strategy. It can give you more money to spend, more money to leave your heirs, and more peace of mind.
Depending on how many "additional" savings are in your portfolio, you can safely withdraw 5% instead of 4% every year with this flexible payout strategy. That gives you a really nice pillow as we'll see.
Read: Check Out Our New Retirement Calculator
True, this plan requires you to tighten your belt sometimes when the market subsides. But when market conditions are favorable, you have more to spend.
It's a smart way to manage your finances in retirement.
Table 1 shows the difference between fixed and flexible withdrawals based on actual results and inflation from 1970 onwards (a decade of abnormally high inflation).
These calculations assume an annual requirement of $ 40,000 and an initial portfolio of $ 1 million that is 50/50 invested in the S&P 500
and pension funds. Columns labeled “Portfolio” show the year-end value.
As you can see, the value of the portfolio held up until 1979.
But the flexible schedule resulted in much smaller withdrawals in the second half of the decade. To keep up with inflation, a retiree needed $ 68,221 in 1979; The flexible arrangement raised just under $ 49,000 that year – providing only about 72% of the purchasing power that a retiree with $ 40,000 had in 1970.
Saving “more than enough” before you retire is not always easy, especially if you start saving in earnest at 40 or 50.
Read: How To Make Up Lost Ground If You Start saving for retirement too late
To do this, you may have to postpone your retirement for a few years. But as you'll see in Table 2, the financial benefits can be impressive.
Table 2 is based on the same assumptions as Table 1, with the exception of an initial portfolio value of $ 1.5 million instead of $ 1 million. This comparison shows what happens when you use a flexible payout rate of 5% versus 4%.
Although the 5% portfolio was slightly smaller than the 4% portfolio in late 1979, there was never any risk of running out of money in later years.
It was worth $ 3.24 million in late 1985, $ 4.4 million in late 1990, $ 6.17 million in late 1995, and $ 8.52 million in late 2000. And of course the withdrawals increased too.
In this hypothetical 1970 retirement, cumulative flexible withdrawals of 5% gave you $ 129,699 more to spend in the first 10 years of retirement, compared to 4%. After 25 years of retirement, at 5% you would have lost $ 204,213 more than 4%.
Having enough money in retirement also has powerful psychological benefits.
On an imaginary emotional scale, having more than enough money can help you move the dial away from fear and closer to comfort and safety.
Here's another thing: Many people view their finances (and wealth) as a way to “count” how well they have lived their lives.
I don't think your net worth measures your worth as a person. And I am not recommending that you live your retired life by a “financial scoreboard”. Even so, a higher score is always nicer than a lower score.
The most important lesson is that it is best to start with more savings than you really need.
And as I'll show in an upcoming article, it doesn't have to be as difficult as you might think.
Additionally, I recorded a podcast on why I believe flexible distributions are a luxury that is worth working for.
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of We're Talking Millions! 12 easy ways to boost your retirement