By | March 14, 2016

Are you saving enough for retirement?  How much money is required to retire?  How long will my money last in retirement?  And, have you considered what size retirement money withdrawal will be safe on a monthly basis?

You really need to consider two pockets of money, or two kinds of capital, for a successful retirement.  Both types of retirement money are needed.  First, you need retirement income funds to provide for your regular month to month expenses.  Second, you will also need to fund a retirement reserve account to cover larger one-time planned or unplanned expenses.

FIRST POCKET: RETIREMENT INCOME FUNDS (to provide you with monthly income)

This refers to the payments you receive from a retirement account, such as a 401(k) plan.

Historically it’s been a fairly safe rule of thumb to withdraw 4% per year from a retirement account, expecting you money to last 30 years.  In theory, this also allows your withdrawals to increase over the years in pace with inflation.  However, before using this ‘rule,’ be sure to talk with your financial advisor; the ‘rule’ may no longer apply in today’s markets.  (See the retirement withdrawal simulation chart from FIRECalc retirement calculator.)

Retirement Withdrawal Simulation

Year-to-year portfolio balances after withdrawing $35,000 annually (and adjusting for inflation) from a $750,000 portfolio every year for 30 years, starting in 1973 (red line), 1974 (blue line), or 1975 (green line).

For the purpose of this article, however, let’s assume you have $500,000 in your plan, and – using the ‘4% rule’ – you are hoping for $1,667 per month from that.  You will want to figure out what rate of return will be necessary to keep you even, or keep enough of that $500,000 growing to sustain you through retirement.  That is, at what rate of return will you be earning $1,667 per month on your investment so that it can “afford” to pay you $1,667 and still be growing at least at the pace of inflation?

Markets can and will rise and fall; volatility is a fact of life.  In addition, bond rates are variable, and many market factors can raise or lower them.  To have your investments free of risk these days is not entirely feasible.  And, if the rate of return on your investments is less than the amount you need to deduct for living expenses, your funds will obviously run out quicker.

It is also possible, due to inflation, that your $1,667 will have a reduced spending power, and you will not be able to afford the same things for the same amount of money any longer.  You may find yourself having to withdraw more than $1,667, and then your retirement “capital” again takes a hit.

Unfortunately, the markets don’t know or care that you are retiring and need a reliable, steady stream of income.  The markets have their own agenda of allocating capital, and it won’t necessarily protect you or your retirement nest egg.  With that volatility, your continued withdrawal of steady funds from a fluctuating account may, in fact, accelerate how fast you run out of money.  That is the “risk” factor for us as retirees.  Throw in the complication of failing health, and a Medicare/health insurance system that is becoming more and more unstable, and you may end up using your retirement to pay your own healthcare.

Don’t be discouraged – this may be your wake up call!!

SECOND POCKET: RETIREMENT RESERVE FUNDS (an account reserved for emergencies or future needs, not for regular expenses)

This is that money that you have stashed away for a rainy day.  This is AVAILABLE cash, that is, not tied up in investments.  This is liquid and “free” to be used as needed, no penalties for withdrawal, etc.

Nobody can tell you exactly how much you will need.  But let’s consider some possibilities of when a cash reserve would be helpful if not required:

A Beautiful Retirement Community

You might want to buy into an intentional retirement community.

  • Will you need to purchase another vehicle in a few years? You won’t want to carry a loan, so having a reserve will be helpful.
  • Will you want to travel, taking that trip of a lifetime that you’ve always dreamed of, a chance to visit new and exotic places?
  • Will you want to have the ability to help a child or grandchild with unforeseen expenses or maybe even expected expenses, such as helping to finance a wedding?
  • Will you look at a retirement community that requires a buy-in of some amount in addition to the monthly fees?
  • Will you want to leave available cash as part of an estate to named beneficiaries to avoid probate and allow the cash to be readily available to those family members?
  • Will you want to have your own health saving account to pay for the increased costs of health care?
  • Will you want to purchase a second home, perhaps in a warmer climate or closer to the grandchildren? You probably don’t want to have to budget a house payment into your monthly allowance.

Summary & Conclusion

While no one can tell you exactly how much you need in either pocket (income capital or reserve capital), clearly both types of retirement money are needed.  A financial consultant can help by discussing what assumptions you are comfortable with and then making some estimates.  This much you can count on: Preparing and having both types of capital – both retirement income funds and retirement reserve funds – in your retirement portfolio is smart.

In addition, many of us should consider creating additional income streams to help finance a comfortable retirement.

Please share your own experiences in the comments below.

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