Retirement savings can be viewed as an account of money to pay your bills once you retire from working for a living. This retirement account, naturally, must have enough money to last your lifetime.
Two other retirement accounts may assist your lifestyle spending in retirement, pensions and social security. However, as pensions are being reduced, and social security was never much to begin with, your most significant account will consist of how much money you’ve set aside for retirement.
Once you have funded your own retirement account and begin spending it, there is a concept called a “withdrawal rate.” This refers to how much of your retirement account you can spend each year with a likelihood that it will last your lifetime. Depending on several assumptions, there is academic research that 4% per year is a robust withdrawal-rate starting point for you to consider. To make this easy for retirees, there are now funds that automatically do this for you and you can choose an annual withdrawal rate, from 2.5% to 5.0%.
You should be aware that a continual reduction of your retirement principal amount is exactly like landing a plane, you want a glide slope that will comfortably last your lifetime for a gentle landing. Too many retirees withdraw too much, too fast, and crash land too early with painful consequences. Even if money isn’t being withdrawn too quickly, a couple bad years in the stock market and it triggers a “sequence of returns” downward spiral of your money dramatically sooner that you had planned. Withdrawing less money in bad market conditions greatly increases the lifespan of your retirement funds.
The most successful retirement plan is one in which there is never any reduction of your principal balance. Your withdrawals are a maximum of your interest and dividend income. Even better, is to leave some interest and dividends to be reinvested so that each year your portfolio income is increasing. The glaring problem with this withdrawal strategy is that your account needs to be large enough when you retire so that the dividends and interest amount to a meaningful amount of money. The annual income in your retirement account needs to be large enough so that you don’t have to remove part of your principal balance in order to pay your bills. The greatest benefit of having an account large enough to do this is the financial peace of mind that you’ve eliminated any potential financial-crash landing from running out of money when you are least able to earn money.