Withdrawal rate is amount of money one can withdraw monthly or annually from a retirement investment portfolio without running out of money.
The money in a retirement portfolio is there to spend. Taking money out reduces the portfolio, but the balance also tends to increase thanks to investment growth.
A withdrawal rate calculation estimates how much money you can take out per year without going broke during the years you need income.
You may have heard of the “rules of thumb” for a safe withdrawal rate in retirement.
Over the last few decades, some have suggested that a 4% annual withdrawal rate was safe.
However, after the longest recession (2000-02) and then the deepest recession (2007-09) since the Great Depression, the industry as a whole has come to agree that maybe retirees need to be a little more conservative.
Here’s a simple trick to get started thinking about your potential withdrawal rate in retirement:
Take 1 and divide it by the number of years you believe you will live. If you retire at 62 and think you’ll live till 90, then 1/28 = 0.0357.
That means you have a 3.57% withdrawal rate.
If you’re 65 and think you’ll live till 85, then 1/20 = 0.05 or a 5% withdrawal rate.
This withdrawal rate calculation works because the older you get, the more you can withdraw. You have less time, so the financial risk is lessened.
Now that we know this, how much do you need to retire? What’s your magic number?
It takes a little backing into the math, but this is why we did the withdrawal rate calculation first.
If you’re going to retire today and you’re 62 years of age, then you know you can safely withdraw 3.57% from your portfolio without outliving your money.
Let’s say you plan on spending $60,000 a year after you retire and your Social Security income will be $20,000 a year.
That leaves you with a $40,000 gap to fill. All we need to do now is figure out how much you need in your portfolio in order to retire today.
So, take $40,000 and divide it by 3.57% and you get $1,120,448.18. (Include the percent symbol when you calculate this on a calculator.)
There you have it! While it takes a few steps, you now have a pretty good start on an retirement income plan.
There’s more to all of this, of course. But these pretty straightforward equations can at least get you into the right frame of mind to make decisions about when to stop working, work less or, perhaps, to continue earning money a few years more.
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