3 steps to make your retirement savings last a lifetime

If I want my savings to support me the rest of my life after I retire, how much can I safely withdraw each year? –Danny

As much as I’d like to, I can’t give you a specific figure. There are just too many uncertainties that come into play when trying to predict how long one’s retirement savings will last.

For example, if your retirement investments fare poorly or you experience a bear market soon after you retire, your money could run out a lot sooner than if the financial markets perform well.

Similarly, having to shell out money for large unanticipated medical costs or other expenses during retirement could wreak havoc with what appeared to be a perfectly valid withdrawal plan.

And then there’s the big unknown of how many years you’ll actually need your nest egg to sustain you after retiring.

But while I can’t give you a quick and easy answer to this important retirement question, I can give you advice on how to approach this issue so that you can come up with a withdrawal strategy that has a good chance of generating the income you need without subjecting you to undue risk. To achieve that goal, I recommend that you take these three steps:

1. Get a sense of how long you might live in retirement. In order to pace your withdrawals so you don’t deplete your nest egg too soon, you’ve got to have an idea of how long you might live. The operative word here is “might.” You can’t predict with any real accuracy when you’ll shuffle off this mortal coil. But you can get a decent enough estimate of how long you might be around by going to the Longevity Illustrator, a tool designed by the American Academy of Actuaries and the Society of Actuaries to help people with their retirement planning.

The thing I like most about this tool is that, unlike other calculators that gauge lifespans, it doesn’t just spit out an estimate of your life expectancy. Although that’s the figure you hear most often in discussions of longevity, life expectancy can be misleading as it represents the average number of years people of a given age and sex are expected to live. But roughly half of people will live longer than that average, many much longer. The Longevity Illustrator allows you to see your chances of living not to just one age, but a variety of ages, based on your sex and state of your health, thus allowing you to make a more nuanced judgment of how long you could end up relying on your nest egg.

So, for example, if you go to this tool, you’ll see that a 65-year-old man who’s a nonsmoker and in average health has a 34% chance of living another 25 years to age 90 and a 16% shot at making it another 30 years to age 95. The chances of a 65-year-old woman making it to those ages are higher (45% and 25% respectively), and the chance that at least one member of a 65-year-old couple (man and woman) will still be alive and kicking at 90 or 95 are higher still (64% and 37%, respectively). Your chances are even higher if you’re in excellent health.

Of course, these are only estimates that pertain to large groups of people, not a guarantee of how long any individual is going to live. Nonetheless, this tool demonstrates that to be on the safe side most people should probably figure that they’ll need their savings to support them at least into their early 90s and in the case of couples into their mid-90s, perhaps longer if their family has a history of long lifespans. What you don’t want to do is underestimate how long you might live — as research shows many people do — and run the risk of depleting your assets too quickly and spending your final years of retirement with little or no savings to fall back on.

2. Start with a reasonable initial withdrawal rate: Once you understand how many years you may be counting on your retirement accounts to supplement Social Security and any other sources of income, you then want to gauge how likely your savings are to last for as long as you need them to given different withdrawal rates.

You can do this sort of analysis by going to T. Rowe Price’s retirement income calculator, which uses Monte Carlo simulations to make its projections. You plug in such information as your age, the number of years you want your retirement savings to last, the amount you have saved for retirement and how much you initially plan to withdraw, and the calculator then estimates the probability that your savings will last that long, assuming you increase your initial withdrawal by inflation to maintain your purchasing power throughout retirement.

So, for example, if you’re 65, have $500,000 in retirement accounts divided equally between stocks and bonds and you withdraw an initial 4%, or $20,000, from your nest egg, this tool estimates that there’s an 80% chance that your nest egg will be able to sustain that withdrawal amount adjusted annually for inflation for at least 30 years. Plug in a lower withdrawal and you’ll get a higher success rate (about 90% for a 3.5%, or $17,500, withdrawal), while going with a higher withdrawal yields a lower chance of success (about 65% for a 4.5%, or $22,500, withdrawal).

Keep in mind that you’re getting estimates of how likely your savings are to last based on forecasts of how the financial markets are expected to perform. These aren’t guarantees. Still, by trying out a variety of scenarios with different withdrawal rates, you can see how your chances go up or down. Based on that you should be able to arrive at a withdrawal rate that has an acceptable margin of comfort for you.

That said, you don’t want to arrive at a withdrawal rate that’s more to your liking by “cooking the books,” so to speak, and plugging in an unrealistically short lifespan or assuming that an aggressive investing strategy will generate returns large enough to support outsize withdrawals.

3. Be prepared to adjust your withdrawals. A withdrawal rate isn’t something you can set once and put on autopilot. So whatever withdrawal rate you start with, you need to be ready to adjust it over the years based on how much of your savings you’ve spent and how well or poorly your retirement investments have performed.

For example, if a market setback or a large withdrawal to meet an unexpected expense has substantially reduced the balances of your retirement accounts, you may want to scale back withdrawals for a couple of years or forgo inflation increases to give your accounts a chance to rebound and avoid depleting them too soon.

If, on the other hand, your nest egg’s value climbs steeply after a string of outsize investment returns, you may want to take the opportunity to spend more freely and enjoy a splurge or two. Otherwise, you could end up late in life with a big pot of retirement savings, and the realization that perhaps you lived more frugally than was necessary.

By going back to the retirement income calculator I mentioned above and re-doing the analysis with updated information every year or so, you should be able to figure out whether you need to adjust your withdrawals to stay on track. retirement2

Bottom line: It’s impossible to identify an ideal withdrawal rate in advance. But if you follow the three steps I’ve outlined, you should have a decent shot at getting the retirement income you need without too high a risk of running through your assets too soon or ending up with more savings than you want in your dotage.