Planning For The Longevity Of Your Retirement Investments

It's a question many people ask themselves: how long will my investments last in retirement? The simplest way to estimate how long your money will last is to weigh up your total savings, plus investment returns over time, against your annual expenses. However, this is not an exact science, and there are many variables at play, from investment returns to inflation and unforeseen expenses, all of which can dramatically affect how long your savings will last.

Regular withdrawals

When it comes to retirement, it's important to understand how long your investments will last, especially if you plan on making regular withdrawals. Here are some key considerations:

The simplest way to estimate how long your money will last in retirement is to consider your total savings and expected investment returns, and compare that to your expected annual expenses. Online calculators can help with this, but it's not an exact science due to variables such as inflation, investment returns, and unforeseen expenses.

One common strategy is the 4% rule, where you withdraw 4% of your savings in the first year of retirement, and then the same dollar amount plus an inflation adjustment in each subsequent year. For example, if you have $1 million saved, you'd withdraw $40,000 in the first year. This rule is based on research that found a strong likelihood of being able to withdraw an inflation-adjusted 4% annually for 30 years if at least 50% of the money is invested in stocks and the rest in bonds.

However, this strategy may be less effective in a volatile market, and financial advisors may recommend dynamic withdrawal strategies that respond to market changes and your evolving needs. These strategies can be complex, and it's worth consulting a professional for advice.

Another strategy is the income floor or "flooring" strategy, which ensures you don't have to sell stocks when the market is down. This approach covers your basic expenses with guaranteed income, such as Social Security, plus a bond ladder or an annuity. While some annuities are overpriced and risky, they can provide guaranteed payments for life, ensuring your basic expenses are always covered.

Retirement calculators can be a useful tool to estimate how long your money will last with regular withdrawals, but it's always a good idea to seek personalized advice from qualified professionals to make sure your retirement strategy suits your specific circumstances.

Annual expenses

When it comes to annual expenses, there are a few key things to keep in mind. Firstly, it's important to note that your annual expenses will depend on your income, retirement lifestyle, and health care costs. As a general rule, you can expect to spend between 55% and 80% of your current income annually in retirement. This is known as your retirement income replacement ratio. For example, if you're currently making $45,000 per year, you can plan to spend around $36,000 per year during retirement.

However, this number is just a starting point and can be adjusted based on your anticipated lifestyle and health needs. If you plan to travel extensively or take up new hobbies, you may need to increase your budget. On the other hand, if you're looking forward to a simpler life, you may be able to reduce your expenses.

It's also important to consider the different categories of expenses you'll have during retirement. These can be broadly categorized into essential, discretionary, and one-time expenses. Essential expenses include must-haves such as housing, transportation, living expenses, family care, and medical/health costs. Discretionary expenses are more optional and include things like entertainment, eating out, hobbies, subscriptions, and travel. One-time expenses refer to unexpected or unusual costs, such as a home repair, a wedding, or a college tuition fee.

Additionally, don't forget about taxes when creating your retirement budget. You may need to factor in federal, state, and local income taxes, as well as property taxes if you own a home.

To ensure an accurate retirement budget, it's recommended to track your expenses for a few months to see if they align with your estimates. This will help you make any necessary adjustments and ensure that your budget is realistic.

By carefully considering your annual expenses and creating a detailed budget, you can make informed decisions about your retirement savings and ensure that your investments last throughout your retirement years.

Investment returns

A popular rule of thumb for retirement spending is the 4% rule, which suggests that you withdraw 4% of your total investments during the first year of retirement and then adjust the dollar amount for inflation in subsequent years. This rule assumes a 30-year time horizon and a portfolio invested equally in stocks and bonds. However, it has been criticised for being too rigid and not accounting for individual circumstances and market performance.

Financial experts suggest that a more realistic annual rate of return is between 4% and 7%. This takes into account factors such as volatility, inflation, and investment fees. The specific rate of return will depend on your asset allocation, with stocks typically providing higher returns than bonds but also carrying more risk.

To maximise your rate of return in retirement, consider the following strategies:

• Invest in stocks, especially value stocks, which can be effective during inflationary periods.
• Purchase Treasury Inflation-Protected Securities (TIPS), a type of bond that increases in value when inflation rises.
• Prioritise short-term bonds, as their interest rates respond quickly to market changes.
• Diversify your portfolio across different asset classes and industries to reduce risk.
• Keep moderate cash reserves, balancing the need for liquidity with the impact of inflation on cash holdings.

Inflation

Over time, rising prices can significantly reduce your spending power when you're living on a fixed income. For instance, if the current 3.7% inflation rate persisted for five years, it would reduce the buying power of a $1 million cash account down to $828,193.

• Delay claiming Social Security benefits. While you can start collecting Social Security at age 62, waiting until you're 70 could give you lifetime monthly benefits that are about 77% higher. This is a way to hedge against inflation, but it may not be suitable for everyone.
• Invest for growth and rebalance regularly. In response to higher inflation and interest rate increases, bond yields have become attractive again. Equities may offer an opportunity for asset growth to exceed the inflation rate over the long term.
• Consider annuities. Annuities are long-term investments designed for retirement purposes, typically issued by insurance companies. They provide a consistent stream of fixed income for life or a specified period. This can give you the confidence to pursue a more growth-oriented investing approach with your remaining assets.
• Prepare for future long-term care costs. Contribute as much as you can to a health savings account (HSA) to help offset rising healthcare costs. Another option is a life insurance policy with a long-term care benefit rider, which could cover some healthcare costs and provide a death benefit to your beneficiaries.

Unforeseen expenses

When planning for retirement, it's important to consider unforeseen expenses that can impact the longevity of your savings. Here are some common unexpected expenses that retirees may encounter:

Inflation and Rising Costs

While inflation is expected, some people fail to factor it into their retirement plans. Costs for household goods, food, and other items are likely to rise over time, and you should ensure that your retirement strategy can accommodate these increases. What seems like a comfortable sum to cover your cost of living today may not be sufficient in the future.

Timing of Social Security Benefits

The timing of when you start receiving Social Security benefits can significantly impact your retirement income. If you begin collecting benefits as soon as you qualify at 62, you will receive lower monthly payments for the rest of your life. However, if you delay receiving benefits until a later age, such as 70, your monthly benefits will be higher, making a considerable difference in your retirement funds.

Family Support

You may find yourself in a position where you need to provide financial support to your children, grandchildren, or even your parents. Economic downturns, personal complications, or health issues could affect your loved ones, and you may need to assist them financially.

Major Home Repairs or Upgrades

Unanticipated major home repairs or upgrades can be costly and impact your retirement savings. It's essential to consider the possibility of these expenses when planning for retirement.

Medical and Healthcare Costs

Out-of-pocket medical or prescription expenses, especially those related to chronic health conditions or disabilities, can be significant and unexpected. Additionally, the cost of hospice care should be considered.

Other Unforeseen Costs

Other unforeseen expenses could include plumbing or electrical emergencies, appliance repair or replacement, car accidents or repairs, pet emergencies and vet bills, school or college tuition and fees, tax increases, and natural disasters.

Frequently asked questions