As people move from working to retirement, they face a number of challenges in adjusting to their new life. But most don’t expect spending money to be one of them. Many families have been saving for retirement for decades. And now that it’s time to finally spend that money, they often don’t know how to do it safely.
There are plenty of resources available to help you figure this out. But for most families, the process it too complex to just find a calculator online and hope for the best. For example, you might have heard about the 4 percent rule of retirement spending. The general principle says if you spend 4 percent of your account value each year, you will never run out of money. As with most financial planning recommendations, there is more to it than that.
Retirement spending strategies
1. If you want to follow the 4 percent rule, consider the following scenario:
You know that you would spend about $5,000 per month in retirement. So here’s how the math breaks down:
- Multiply $5,000 by 12 months to get $60,000 in spending each year.
- If you take the $60,000 from an IRA, you will pay federal and state income tax on it. In Minnesota, you might end up paying about 30 percent income tax on the IRA distributions. So, you need to take out $86,000 each year to spend $60,000.
- Divide $86,000 by 4 percent to get the size of the IRA you would need to provide that money. The total comes to about $2,150,000.
2. If you want to plan for inflation and the impact of periodic market pullbacks, you probably want a more complex analysis and some professional advice.
3. If you are not sure about your spending needs in retirement, that’s a great place to spend some time and maybe seek advice. The monthly retirement budget is the foundation on which everything else rests. Get this part right. It’s important.
4. If both spouses worked most of their lives, be sure to look carefully at Social Security benefits. If you plan shrewdly, you might be surprised how much Social Security could help. It’s worth some homework and maybe professional advice.
Retirement planning
As you plan out your financial future, remember, markets rise and fall. Usually they are up three out of every four years. In a down year, it’s a good idea to reduce your distributions, if you can. This is why it’s important to conduct an ongoing review of your distribution plan so you can review and adjust each year based on the current situation.
Also, it’s a great idea, especially in the early years, to keep a few years’ worth of distributions in cash and fixed accounts. That way you know where the money is for the next 36 to 48 months, regardless of any temporary change in your account value.
If you keep three years of cash, you can wait three years for the value of your stocks to recover before you need sell any to fund a retirement distribution. It’s a very simple idea, but a powerful one.
The transition from earning and saving to spending and enjoying is a critical time. Many families really appreciate having the advice of a professional financial planner who works as their advocate (a fiduciary advisor) and who only gets paid by the client (a fee-only advisor) to provide perspective and unbiased advice.
If you want to talk about your retirement spending plan, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on financial goals.
Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.
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