For quite some time there have been numerous studies out there that have tried to tackle the question of how much a retiree can withdraw from their retirement savings without running out of money.
People in the industry call this the safe withdrawal rate. The rate most commonly talked about and put into practice is the so-called 4% rule.
In the early 1990s, CFP William Bengen produced work that found that 4% was a safe rate of withdrawal to determine if your nest egg was sufficient to last for 30 years.
So to put this in application, if you know that your retirement expenses would be for example $50,000, then you could multiply this number by 25 - which is the inverse of 4%. In this example your total retirement savings should be $1,250,000.
As you may have realized, this rule of thumb will almost always overestimate your needed amount because it doesn't account for income during those 30 years.
But here's a catch. Bengen made the follow assertions with his work:
If you change one of these factors, your safe withdrawal rate will change with it. But that's just the tip of the iceberg.
Recently, new research has looked into other variables that affect how much you will need in retirement.
Here's what's becoming the "new school process" in determining what you need to safely retire.
Basically, there is no credible formula where you can simply plug in a percentage. You have to take a piece-meal approach.
A lot of attention lately has been given to the work of Todd R. Tresidder, a former hedge fund manager and founder of FinancialMentor.com. His book, "How Much Do I Need to Retire?" - published last August - gives us a framework in figuring out withdrawal rates that touches on some of the new research out there.
Here are some tips:
First: Estimate your life span. There are actuarial tables that the IRS provides for you when calculating Minimum Required Distributions from your tax deferred retirement accounts after age 70 ½. Remember that these are group population expectancies that may not pertain to you. Your health and family history may give you an entirely different picture than those tables. And this generation is living longer than the previous one.
Second: Don't ignore market cycles. We can't exactly pinpoint market cycles, but we can keep an eye out for them. The importance of this variable is that if you start withdrawing money at the beginning of a bear market, you may be withdrawing too fast. That could put your nest egg in jeopardy over the long run.
Third: You must take into account inflation. A pretty good estimate of the inflation rate needs to be added in any kind of retirement calculation. Why is it so important? Inflation will affect your return over time. Little changes in inflation could have huge implications to your needed nest egg. And remember that government-reported numbers tend to underestimate the effect of price increases on your wallet.
Finally: Periodically take a look at your plan. This process is not simple and is more like a living/breathing process. Take for instance the last six to seven years. Look at everything that's happened to the markets since 2005 - 2006. The entire investing world has turned upside down. Vigilance will be a necessity.
These tips are just part of how you can take your retirement savings into your own hands, instead of leaving it up to outdated rules and money managers.
Another component of a healthy retirement savings is being prepared against market corrections.
Our Executive Editor William Patalon III has found one of the best ways to protect your retirement savings from disappearing into volatile market moves. Check out his tip for holding on to your money.
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