Retirement Spend-Down: A Guide to Making Your Money Last

Retirement can be a time of great freedom and relaxation, but it can also be a time of financial stress if you're not careful with your money. In fact, a recent study found that 1 in 5 retirees run out of money within 5 years of retirement.

One of the biggest challenges retirees face is making their money last as long as possible. This is where the concept of retirement spend-down comes in. The idea is to gradually reduce your expenses as you age, so that you can make your money stretch further.

A good rule of thumb is to aim to spend no more than 3-4% of your retirement portfolio each year. This will give you a good chance of making your money last, and will also help you avoid depleting your assets too quickly.

Worth a look: How Does Steve Will Do It Spend so Much Money?

Spending down your retirement savings is a deliberate strategy to create income in retirement by drawing from your accumulated assets. This approach is different from other retirement philosophies that focus on preserving a significant portion of your nest egg.

The core idea of spending down is to utilize your savings to meet your living expenses and lifestyle needs. This allows you to enjoy the rewards of your labor and pursue your passions.

There are several compelling reasons to consider spending down your retirement assets. You've worked diligently to build your retirement fund, and spending it within reason allows you to experience the rewards of your labor and pursue your passions.

Avoiding unintentional bequests is another reason to consider spending down. Leaving a large inheritance might be well-intentioned, but if it comes at the cost of sacrificing your comfort and enjoyment during retirement, it might be worth reconsidering.

Spending down strategically helps ensure your needs are met throughout your lifetime. This reduces worries about outliving your savings, giving you peace of mind.

To illustrate the importance of planning, consider creating an annual projection that lines up income, expenses, and withdrawal needs. This projection may provide the baseline for how much you can expect to spend in retirement and how long the money will last.

Here are some common strategies for spending down:

The first step to a good retirement plan is to evaluate your current and projected annual expense needs. This allows you to begin planning for where the money will come from to meet your needs.

A popular guideline is to assume you need approximately 75-80% of your pre-retirement spending need in retirement. For example, if you spend $100,000 per year prior to retirement, this rule of thumb suggests you need $75,000 to $80,000 per year in retirement.

You should create a budget that reflects your current, known expenses and a projected budget to clearly identify what you need to cover your short-term and long-term costs. Include expenses such as housing, healthcare, real estate taxes, travel, food, household expenses, and so on.

Consider how those expenses might change once you stop working. You should also plot non-annual expense needs such as college, weddings, big vacations, gifts to children, and/or gifts to charity.

Consider reading: Where to Retire on $100k per Year?

You can reduce your reliance on your nest egg by funding your lifestyle with other income sources first. This approach allows you to minimize withdrawals from your investment portfolio, potentially making it less likely that you'll run out of money in your lifetime.

Social Security benefits can be flexible, allowing you to begin receiving your benefit as early as 62 or as late as 70. A pension may also have some flexibility, with options that could include a life-only benefit or a joint benefit.

A pension can provide a steady income stream, with some distributing $15,000 per year, as in our example. This can help cover a significant portion of your costs, reducing the amount you need to withdraw from your investment portfolio each year.

Historically speaking, lower-earning assets include cash, money markets, CDs, and other fixed income instruments, which typically earn lower returns.

Broaden your view: Capital Budgeting Decisions Include

Supplementing your nest egg with other income sources can be a game-changer in retirement.

You might enjoy: 457b Withdrawal Rules

You can reduce your reliance on drawing down assets by funding your lifestyle with other income sources first. Common income sources include Social Security benefits and pensions.

Social Security benefits are flexible, allowing you to elect to begin receiving your benefit as early as 62 or as late as 70. A pension may also have flexibility, with options like a life-only benefit or a joint benefit.

If you need $118,000 per year in retirement, and your Social Security benefits add up to $30,000 per year, you can reduce your need to draw down from assets to cover all your costs. Your pension can also help, distributing $15,000 per year.

By using other income sources first, you can reduce your net need to withdraw from your investment portfolio each year. In our example, that's a net need of $73,000, which is less than the original $118,000.

Intriguing read: Taking Social Security Early and Investing It

If you need to withdraw from investments and accounts, it's essential to understand the tax implications.

The IRS considers withdrawals from traditional IRAs and 401(k)s as taxable income, which can increase your tax liability.

You can withdraw from your retirement accounts penalty-free after age 59 1/2, but it's still considered taxable income.

Some retirement accounts, like Roth IRAs, allow tax-free withdrawals if you meet certain conditions, such as a first-time home purchase or a qualified education expense.

Before withdrawing from your accounts, review the fees associated with early withdrawal, as they can significantly reduce your savings.

It's also crucial to understand the impact of withdrawal on your Social Security benefits, as excessive withdrawals can reduce your benefits.

In some cases, you may be able to withdraw from your retirement accounts without penalty, such as if you're using the funds for a first-time home purchase or a qualified education expense.

A unique perspective: Capital Budgeting Is Used to Evaluate the Purchase Of:

Having peace of mind is a crucial aspect of retirement, and it's often linked to the presence of insurance. The value of this peace of mind can be substantial, allowing individuals to better enjoy themselves in retirement.

Research from the University of Michigan found that holding an annuity can lead to increased spending, suggesting that self-insurance may be a factor in retirees holding onto their assets. People are essentially insuring against low-probability, high-impact events, which can limit their ability to enjoy their retirement.

The "spending smile" is a well-documented phenomenon where nominal spending in retirement starts high, declines over time, and then ticks up again due to late-in-life health costs. This pattern is at odds with the 4% rule, which advises taking the same amount and adjusting for inflation every year.

The 4% Rule is a popular guideline that suggests withdrawing approximately 4% of your retirement assets in your first year of retirement and adjusting that amount annually for inflation. This can be a good starting point, but individual circumstances may warrant adjustments.

Flexible spending involves evaluating your income needs year by year, allowing you to adjust your withdrawals based on market performance, unexpected expenses, or changing desires. This approach can help you make the most of your retirement savings.

The Bucket Strategy divides your assets into different "buckets" based on time horizons, covering short-term needs with cash and less volatile investments, while longer-term buckets can include stocks that offer growth potential. This method can provide a more tailored approach to spending down your retirement assets.

Annuity Income provides a guaranteed income stream for a specified period or even for life, offering peace of mind against outliving your assets. This can be a valuable option for those who want to ensure a steady income in retirement.

Here are some common strategies for spending down in retirement:

By considering these strategies and finding the one that works best for you, you can enjoy a more fulfilling retirement and make the most of your hard-earned savings.

Your projected lifespan influences how aggressively you can draw down your savings. If you expect to live a long life, you may need to be more conservative with your spending.

Inflation can erode your purchasing power over time, so it's essential to factor it into your plan. A 3% annual inflation rate can significantly impact your budget in 20 years.

Market ups and downs can impact your portfolio, so it's crucial to have a strategy in place to account for potential downturns. Be prepared to adjust your spending plan accordingly.

Here are some key factors to consider:

Unexpected expenses can arise, such as healthcare costs or home repairs. Having some flexibility in your budget can help you address these potential expenses.

Life expectancy plays a significant role in determining how aggressively you can draw down your savings. A shorter life expectancy means you may need to be more conservative with your spending.

Inflation can erode the purchasing power of your money over time. For example, if inflation is 3%, your money will be worth 3% less in a year, assuming all other factors remain constant.

Market volatility can be a major concern when planning your spending. A study found that the S&P 500 index has experienced a decline of 10% or more in 17 of the past 90 years.

Unexpected expenses can arise at any time, and it's essential to have some flexibility in your budget to address these potential expenses. Healthcare costs, long-term care, or home repairs can be particularly costly and should be factored into your planning.

Here are some key factors to consider when planning your spending:

Loss aversion is a behavioral bias that can significantly impact our financial decisions, especially in retirement. People tend to think more about the bad outcomes that might happen.

According to research in behavioral economics, people exhibit loss aversion, meaning they dislike losses more than they like gains. This can lead to irrational decisions, such as holding onto savings too tightly.

In retirement, loss aversion is even more pronounced, as people are anchored to their saved principle and become averse to seeing the balance drop. This can make it difficult to take calculated risks or make adjustments to their financial plans.

Recommended read: Hedge Fund Financial Analyst Salary

Familiarity bias is a common pitfall in retirement planning.

As you've been saving for 30 or 40 years, it's natural to think you should continue to follow the same rule: don't spend more than you bring in.

This bias can make it difficult to adjust to retirement, where your income may be lower or irregular.

InsuranceNewsNet editor-in-chief John Forcucci notes that this bias can be a challenge for retirees, who must suddenly switch from saving to spending.

You've been following the same rule for decades, but retirement requires a different approach.

It's essential to recognize this bias and adjust your spending habits accordingly, as John Forcucci suggests.

Readers also liked: Internal Rate of Return Decision Rule

Planning is a crucial step in a successful spend-down strategy. Careful planning helps create a comprehensive plan tailored to your unique situation, considering income sources, expenses, risk tolerance, and goals.

Consulting with a trusted financial advisor is a great way to get started. They can help you understand the concept of spend-down and develop thoughtful strategies to make the most of your retirement years.

Spending down your retirement savings allows you to make the most of your retirement years. By understanding the concept, employing thoughtful strategies, and seeking professional advice, you can create a fulfilling and worry-free retirement experience.

Research shows that many people reduce discretionary spending or adjust their budgets in retirement. In fact, 73% of retirees reduce discretionary spending, while 67% adjust their budgets.

A Safe Money approach can also help reduce volatility. Our Safe Money Guide, now in its 20th edition, is available for free as an instant download.

Here are some key points to consider when planning your spend-down strategy: