What if there were a “best” strategy to determine how much you can safely spend in retirement? Lucky for you, there is such a method, as determined by some of the best minds in the field of retirement. Today we’re taking a look at it.Today, we're looking at the best strategy to determine how much you can safely spend in retirement... Click To Tweet
Good news: There is one strategy which has been recommended as the best at determining how much you can safely spend in retirement, and this post summarizes the strategy. This article is a “must read” for anyone interested in figuring out how much you can safely spend in retirement.
The process is easy, and it works.
The conclusion of which strategy best determines how much you can safely spend in retirement is based on research by the Stanford Center On Longevity, who researched 292 retirement income strategies and determined that one was better than all of the rest. Without further adieu, the recommended methodology to determine how much you can safely spend in retirement is called…
The Spend Safely In Retirement Strategy
Moving from an accumulation phase to a withdrawal phase is one of the biggest financial adjustments for retirement, and it causes anxiety for many folks. It’s also an area of retirement planning that tends to have less coverage in the press. Fortunately, some very smart folks (including Wade Pfau, one of the best minds in the field of retirement finance) have done the research and determined that “The Spend Safely In Retirement” strategy is their recommended strategy for determining how much you can safely spend in retirement.This strategy is recommended by the experts as the best to determine how much you can safely spend in retirement. Click To Tweet
A Summary Of The Spend Safely Strategy:
In a nutshell, The Spend Safety In Retirement Strategy has the following key elements:
- Using the Required Minimum Distribution (RMD) formula to calculate annual withdrawals from your portfolio.
- Prior to Age 70, the strategy recommends a 3.5% withdrawal rate (RMD starts at Age 70.5).
- Invest your portfolio in low-cost mutual funds (target date, balanced and/or stock index funds)
- Delaying Social Security until the age of 70 years of age.
- Spend only what the RMD formula “allows”, plus Social Security after Age 70.
Below, I provide a hypothetical example of this strategy to demonstrate how you can use it to determine how much you can safely spend in retirement. First, let’s look at the benefits of The Spend Safely Strategy compared to the other 292 strategies evaluated.
The Benefits Of The Spend Safely Strategy
One of the chief advantages of this plan is that it’s straightforward and can be implemented by individuals from their existing retirement savings, while also greatly reducing the risk that you’ll outlive your savings. When Steve Vernon wrote a piece on this strategy for CBS, he included this relevant quote:
The “Spend Safely in Retirement” strategy represents a straightforward way for middle-income workers with between $100,000 and $1 million in savings to generate a stream of lifetime retirement income without purchasing an annuity and without significant involvement from financial advisers. This group might represent as many as half of all workers age 55 and older.
It Produces More Income, For Life.
Compared to most other 292 solutions that the study analyzed, the Spend Safely strategy produces more expected total average retirement income throughout retirement. Since maximizing our income (and thus, the amount that we can spend safely in retirement) is a critical element in our retirement planning, this is a key factor favoring this strategy. While annuities can guarantee income, the research found that their total income generation was lower than the expected return from the Spend Safely Strategy.
Further, it provides a lifetime income, no matter how long the participant lives. By automatically adjusting the withdrawal each year for investment performance and remaining life expectancy, this strategy automatically adjusts how much you can safely spend in retirement with each passing year, increasing the odds that you won’t outlive your money. It is important to realize, however, that this may lead to having to lower your standard of living in a period of low returns. Finally, the methodology creates an amount you can spend safely in retirement which is expected to increase moderately in real terms, while many of the other models studied aren’t projected to keep up with inflation.
Since the calculation is done annually, it automatically adjusts the spending amount for the following year to recognize investment gains or losses. Spending (withdrawals) are increased after any year with a favorable return but decrease after an unfavorable return. Note that this could create income variability through retirement, but doing so increases the strategy’s ability to provide for an income regardless of how long you live. Compared to some of the other plans, this strategy produces low measures of downside volatility.
It also gives older workers the flexibility to transition from full-time work to part-time work to full retirement. In fact, the need for part-time work may be required to meet the strategy’s recommendation of delaying Social Security until Age 70. Again, that can be painful for some retirees with insufficient savings, but it also highlights the need for the part-time work before it’s “too late”, when the retiree realizes they’ve overspent their savings. (BTW, if you’re interested in more reading on why deferring SS makes sense, check out this post from Wade Pfau)
By avoiding annuities, the strategy also increases accessibility to ones’ savings for flexibility and the ability to make future changes. It also provides an increased chance of being able to leave money to your heirs, given the annual adjustment to your spending levels.
An Example Of The Spend Safely Strategy
Below I have calculated a scenario for The Spend Safely In Retirement Strategy which allows you to see how it would evolve over the life of our hypothetical retiree.
Jane is 60 years old and has $1 Million in savings. We’re going to assume she’s eligible for $24k per year in Social Security at Age 70, which will increase at an assumed 2% COLA adjustment per year. Based on this strategy, the amount that she can safely spend in retirement is calculated in the gray column:
Key Takeaways From The Example
Jane can only afford to spend $35k when she retires at Age 65 (3.5% of $1 Million). The spending increases after Social Security kicks in at Age 70. The authors state that delay of Social Security until age 70 is a crucial element of this strategy, and folks must have sufficient savings to cover their expenses during the deferral of their Social Security. If this isn’t possible, they warn, the individual should consider continuing to work in order to allow the delay in the start of Social Security payments. Having said that, the study also states, “The strategy works best when the retiree delays Social Security until age 70, but delays until earlier ages, such as 67, 68, or 69 still provide significant advantages.”
The Required Minimum Distribution table from the IRS is used to calculate the withdrawal rate after Age 70 1/2. Prior to Age 70, the study recommends limiting withdrawals to 3.5% of retirement savings. These figures are shown in the “Withdrawal %” column in the table.
I’m assuming a very conservative 5% rate of return in the example. Modeling a flat rate of return is a very dangerous assumption in calculating how much you can safely spend in retirement since it avoids highlighting the very real sequence of return risk. I’m also assuming Jane is a conservative investor, with a heavy allocation to fixed income investments. The same disclaimer applies to the use of a fixed inflation rate of 2% in the example. If you’d like to play around with my assumptions, you can save a copy of the spreadsheet here.
A final note about Jane’s $1 Million opening balance. Don’t Forget Taxes! Your retirement spending level needs to absorb the tax burden, which can be a significant number if the majority of savings are in a Before-Tax IRA.
If You’re Interested In Reading More
If you’re interested in learning more about this strategy to determine how much you can safely spend in retirement, I encourage you to read the original study here. For the most comprehensive analysis of withdrawal rates I’ve ever seen, check out The Ultimate Guide To Safe Withdrawal Rates by EarlyRetirementNow. Articles on the Spend Safely Strategy have also appeared in CBS, The Retirement Cafe and New Retirement.
BTW, I’m a big fan on NewRetirement’s Retirement Planner. They’ve built in the RMD calculation, and offer one of the most robust retirement calculators in the industry. I gain nothing by having you click that link but would recommend it if you’d like an excellent calculator to run some Smart Spending analysis on your own. They also offer great support if you have any questions as you work through various retirement scenarios.
Make sure you fully understand the positives and negatives of any strategy before implementing it in your personal situation, especially something as important as determining how much you can safely spend in retirement. Also, note this study was specifically looking at middle-income investors with portfolios of $1M or less. For those with larger investment portfolios, other solutions may be better suited to your individual situation.
How much can you safely spend in retirement?
Running out of money is one of the biggest worries when determining when you can retire. When a group of experts aligns their recommendation on one strategy out of 292 strategies they studied, we’d be wise to listen. The Spend Safely In Retirement Strategy is an easy methodology to apply to your existing assets and should be one that you seriously consider.
Even though I’ve only recently learned of this study, I’m essentially using this strategy in our retirement. We’re using a more conservative 3% safe withdrawal rate since I retired a bit early at Age 55 (vs. the plan’s 3.5%). We do plan on deferring Social Security until Age 70 and will be revisiting the RMD calculation when we establish our annual spending level after Age 70 1/2. If you’re interested in seeing the details of our strategy (along with 22 other folks who have contributed linked posts on the topic), click: “Our Retirement Investment Drawdown Strategy”.
Your Turn: If you’re retired, how did you calculate how much you can safely spend in retirement? What do you think of the Spend Safely Strategy? Any advice for those still figuring out how much they can safely spend in retirement?