During your working years, it’s a little easier to live within your means. Most people are getting a fixed paycheck at regular intervals, so calculating your monthly income is usually a pretty straightforward affair.
One of the biggest changes when you hit retirement is a departure from that predictability. Most retirees suddenly depend on a mix of different income sources, some of which don’t pay fixed amounts.
While it’s tempting to take those long overdue trips or spoil your grandkids once you stop working, it’s more important to establish a firm budget. The last thing you want to do is overspend now, only to find yourself in a pinch years down the road.
The first step is to understand where your money is going to come from and how much you can expect each month. Common sources include Social Security payments, pension disbursements and withdrawals from investment accounts. The latter can include taxable accounts as well as non-taxable accounts such as Roth 401(k)s and Roth IRAs.
Think of Social Security and your pension – if you’re lucky enough to have the latter – as the bedrock of your retirement budget since both typically offer fixed payments for life. The challenge is to figure out how much to pull from your investment portfolio so you can supplement that income.
Over the past couple of decades, a popular rule of thumb has posited that Americans can withdraw 4% of their invested assets during the first year of retirement and then adjust their allowance in subsequent years based on inflation. That should make your money last for at least 30 years, according to conventional wisdom.
However, there are a couple of reasons why you might be better off with a more conservative allowance. For one, the 4% rule assumes a fairly rosy picture of the stock market. Those who retire during a market downturn may have a harder time building their accounts back up again in later years.
The other point to consider is that Americans are simply living longer than they used to. Roughly one of every four adults expects to live to at least the age of 90, and for those who do hit that birthday, their life expectancy is another five years. That means planning for a 30-year supply of cash might not cut it anymore.
If you really want to play it safe, starting off with a 3% withdrawal of your assets might be an even better plan. But what is the best asset allocation during retirement? We explore that question in the next section.
Structuring Your Assets