Back in the day, most workers never had to worry about whether their retirement savings would be enough. A pension provided a fixed monthly income that lasted a lifetime — no calculations required. That pension, along with Social Security, had you covered for your golden years.
These days, retirement income planning is a whole new ballgame, and it appears Americans aren’t playing very well. With the demise of pension plans and the rise of defined contribution plans like 401(k)s, retired Americans now have a lump sum consisting of the contributions they socked away, as well as any company match and profit sharing.
Their next step is to figure out how much to take out each month — not too much to deplete the funds, but enough to live on and keep up with inflation. This is what’s known as a “safe withdrawal rate.”
”Without the peace of mind that pension income provided to previous generations, pre-retirees are the first generation that needs to turn their savings into adequate income in their retirement on their own,” Dylan Huang, head of retirement solutions for New York Life, said in a new report by New York Life and Ipsos Public Affairs.
77% of people over 40 don’t know how much of their nest egg they can spend annually without risking running out of funds, according to the study. When they guessed, over 30% of them were pretty far off — they felt a safe withdrawal rate from their savings was 10% of their account balance each year.
In reality, industry experts debate whether 4% or 3% of an account balance each year is a safe withdrawal rate for lifetime income.
The calculation takes into account the projected growth of the portfolio, an annual adjustment for inflation, and life expectancy. The goal is to have a high probability of success — 95% — that funds will last to life expectancy as the investor draws them down.
One thing experts do agree on is that taking out 10% per year in retirement is just not realistic. In fact, according to the study, retirees will run out of money in 11 years at the most if they take out 10% per year. This is well below the average life expectancy. How can you determine if you are on track to provide an adequate lifetime income in retirement?
The first step, according to Huang, is “knowing that anything over 5% is way too high.”
The second step is to run a personalized retirement income estimate to see if you are on the right track. Enlisting the help of a Certified Financial Planner™ Professional or fee-only financial advisor may be in your best interest, as this is more complex than it may appear. Alternatively, your HR department at work may have some calculators or financial guidance available.
When you do run calculations, be sure to take off your rose-colored glasses and use reduced return expectations, higher inflation estimates, and a longer life span, just in case.
“Plan for the worst and hope for the best” applies here. Planning for poor performance and increased income needs can help you add a buffer for the unexpected.
This article was written by Nancy Anderson from Forbes and was legally licensed through the NewsCred publisher network.
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