You may be one of the fortunate ones, having saved up a substantial amount for your retirement. Perhaps, though, you’re still on the road towards feeling totally secure with your retirement. Regardless of where you stand, we’re all on the same financial trek towards a comfortable retirement. On this journey, it’s important to make sure your money lasts comfortably throughout retirement so you can enjoy your golden years to the fullest.
Depending on which category you fall into, your money will play a different role. If you fall into the pre-retiree category, or are over 40 years but are more than five years away from retirement, then you are looking to have efficient retirement income options available to choose from when it comes time for you to leave the workforce. If you are already retired, or five years or less away from it, you are considered a retiree and will need to be able to analyze and choose from the income options that you have available to you in order to accomplish your retirement objectives.
So, the purpose of any long-term savings or investment is to create retirement income, liquidity, as well as a sizable inheritance for your loved ones. However, when it comes to accumulating retirement income and inheritance, or legacy, there are two common questions that pre-retirees have:
1. How much do I need to save?
2. Where do I need to put it?
Any decent financial planner or advisor would be able to come up to answers to these questions with a retirement plan that will provide tax advantages and a good rate of return on your savings during what is known as the “accumulation phase” of retirement. To put it simply, the accumulation phase started when you showed up for your first-ever day of work and, if you’re not already retired, has continued every year since. Unfortunately, many investment advisors and financial planners fall short in appropriately planning for the “distribution phase,” or the retirement phase when you are actually spending the money you’ve accumulated over your working life. The two factors these advisors miscalculate are:
- Longevity, or how long you are going to need to draw from your retirement
- Retirement Income Rate, or what percentage of the funds will be withdrawn over a span of time to maintain a certain lifestyle
These two factors, while seemingly separate, blend together when you consider the implications of misunderstanding your retirement income rate. A survey done by Fidelity Investments illustrates this. They asked over 1,000 pre-retirees what percentage of their savings financial experts suggested they can withdraw annually in retirement. Of respondents, 19% said they believed they could withdraw 7-9% of their total savings each year. That’s an amount most retirement experts would agree puts them at very high risk of outliving their nest egg.
Leading to an even more bleak outcome for retirees. In short, nearly 4 out of 10 of the soon-to-be retirees surveyed had an unrealistic view of how much they could spend each year without jeopardizing their retirement security.
You’re probably wondering, what is the right answer to this question that almost 40% of the aforementioned respondents got wrong? Financial professionals disagree on the exact percentage, but many, including Fidelity, agree that it should be no more than 4%. This is in line with the results of a 1994 study done by a now-retired financial planner, William Bengen. This study has risen to prominence amongst financial planners and has become simply known as the “Bengen rule.” Though it is worth mentioning that experts are beginning to question this number due to instability.