Saving up enough money is the first step of retirement. You also need to determine how much you can spend without running out of money in your later, more vulnerable years. Other retirement income sources such as Social Security and income from a part-time job also play a major role in retirement spending decisions. Here’s how to calculate a safe retirement spending rate.
Start with your Social Security benefit. Check your Social Security statement to get an estimate of your monthly payment. Remember that your monthly payments are lower if you sign up before your full retirement age and increase for each month you delay claiming up until age 70. Don’t forget to account for Social Security taxes, if they apply, and the amount deducted for Medicare premiums. Social Security also offers some protection against inflation, the death of a spouse and outliving your savings.
[See: 10 Ways to Increase Your Social Security Payments.]
Consider your pension and part-time job income. If you’re lucky enough to have one, get an estimate of your future pension payments. Then add in any supplemental income. For most retirees, that typically comes from a part-time job. However, given the realities of holding down a job when you’re in your 60s or 70s and the unpredictability of the job market, you can’t count on that income forever. Think of your part-time job income as a supplement to shore up a weak spot in your income flow or a way to support extra sending on travel or grandchildren.
Withdrawals from savings. Many retirees keep some cash in regular savings accounts and spend it as the need arises. But spending without a plan can leave people vulnerable in the future if they spend down their savings too quickly. Other retirees are too conservative. They view their savings as a rainy day fund, withdrawing as little as possible, fearing they might someday run out of money. This method often forces people to make unnecessary sacrifices, just so their heirs can spend the money.
A spending strategy can prevent you from using up your savings too quickly or being unnecessarily frugal. For example, the 4 percent rule allows you to withdraw 4 percent of your savings each year and increase that amount by the rate of inflation. Another strategy involves buying an annuity from an insurance company. You hand over a lump sum in return for a stream of income for a period of time, usually the rest of your life. But some retirees don’t feel comfortable giving up control of assets they may need in an emergency.
[Read: How Much Should You Contribute to a 401(k)?]
The required minimum distribution strategy. The government requires retirement account participants to withdraw specified amounts from individual retirement accounts and 401(k) plans each year after age 70 1/2. Following the government’s required minimum distribution schedule can also be a solid retirement spending strategy, especially when combined with delaying claiming Social Security until age 70, according to research by the Stanford Center on Longevity.
Required minimum distributions are calculated by dividing your account balance by an IRS estimate of your life expectancy. The life expectancy used for the calculation changes as you age, and ranges from 27.4 years at age 70, to 18.7 years at 80 and 11.4 years at 90. At age 70, when you divide your total savings by the factor listed for your age on the IRS table, you get a withdrawal amount of about 3.6 percent. By the time you’re 80, you must withdraw about 5.3 percent. You can also apply the required minimum distribution withdrawal percentages to your regular savings account.
The required minimum distribution strategy allows you to adjust withdrawals from your savings to reflect your remaining life expectancy and investment performance. Since the calculation uses your account balance, the dollar value of your withdrawals is smaller in years when your investments decline and increases to reflect investment growth, which can help to preserve your assets. This strategy allows you to spend as much as possible, without running out of money in later years.
[See: How to Pay Less Taxes on Retirement Account Withdrawals.]
Remember to factor in the income tax that will be due on required minimum distributions from traditional retirement accounts. After years of deferring income tax on your savings in traditional 401(k)s and IRAs, retirees need to pay income tax on each withdrawal.
Tom Sightings is the author of “You Only Retire Once” and blogs at Sightings at 60.
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