Spending Confidently in Retirement

Retirement Planning Article

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Spending Confidently in Retirement
by Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
Updated November 10, 2008

Most investors want a comfortable retirement. Yet many of us, particularly the baby boomers, could do a better job of planning for this most important of goals.

Ultimately, financial planning isn't just about rates of return or picking the right stocks. It's about peace of mind and achieving your dreams. Nowhere is this more important than in planning for a retirement that lets you spend reasonably, with confidence.

Of course, the key is to have a plan in the first place. But, how do you go about estimating your needs for something like retirement spending, particularly if retirement is still far into the future?

Cash flow: the key to a comfortable retirement
Retirement planning boils down to cash flow. How much money do you need to spend each year to meet your obligations and still maintain the standard of living you desire?

During your working years, you maintain yourself primarily by earning an income. In retirement, you'll likely rely heavily on your financial portfolio. Retirement planning involves three steps:

Determine your retirement spending needs.
Figure out how large your portfolio must be to fund your retirement spending.
Calculate how much you need to save and invest now to reach your retirement portfolio goal.

Let's take a closer look at each of these steps.

Step 1: Determine your retirement spending needs
How much are you likely to spend in retirement? Where will you live? Will you still have a mortgage or pay rent? How much will medical insurance cost? How long do you expect to live? Do you want to provide for heirs or charities?

These questions can help you determine your cash flow needs. You'll also need to factor in any other fixed expenses, inflation, taxes, and whether you'll have sources of income other than your portfolio.

One school of thought says you'll need 75 to 80 percent of your pre-retirement income in retirement. However, a safer assumption is that you'll need about as much annual income in retirement as you did before retirement (less whatever you've been putting aside each year for retirement, of course).

Step 2: Figure out how large your portfolio must be to fund your cash flow needs
How much should you have saved to fund your retirement spending needs? After running thousands of simulations for different risk profiles and time horizons, we found some general guidelines that may help you plan for retirement.

For example, in order to have a beginning annual retirement income of $40,000 that keeps pace with inflation, a moderate investor with a 30-year retirement time horizon would need to have approximately $1 million socked away. This translates into a withdrawal rate of roughly 4 percent of the portfolio's value in the first year of retirement, which is then grown for inflation over the rest of the retirement time horizon.

Depending on your risk profile and time horizon, the following table should give you an idea of how much you'll need to accumulate for every $1,000 of monthly retirement income. And it does so with an approximate 90 percent confidence level that you'll be able to keep pace with inflation and not run out of money prematurely:

What you may need for each $1,000 of monthly income for approx. 90% confidence level¹

Asset Allocation
Time in retirement	Conservative	Moderately conservative	Moderate	Moderately aggressive	Aggressive
20 years	$220,000	$230,000	$240,000	$250,000	$270,000
30 years	$300,000	$300,000	$300,000	$330,000	$340,000
40 years	$370,000	$350,000	$360,000	$370,000	$410,000

1. Based on Monte Carlo simulations using reasonable capital market expectations.

How might you increase your chances of not running out of money?

Spend less in retirement. Based on further simulations, we found that taking less cash out of our hypothetical portfolio has the biggest impact on the level of confidence. Besides providing the most bang for the buck, changing your level of spending may be the most practical way to increase confidence.
Save more. Retiring with a larger portfolio also raises the confidence level. This could mean saving more earlier on or postponing retirement for a few years.
Increase your potential return by taking on more risk. While appropriate for younger investors still in the early stages of retirement saving, for those near or in retirement this has the least impact. Taking on more risk could have a diminishing impact on the ability of the portfolio to sustain cash flows past a certain point, because the expectations for higher volatility tend to undermine the benefits of higher potential return. Increasing risk does carry greater potential for building wealth beyond what you'll need to merely sustain your minimum cash flows, but a riskier portfolio may not be practical for retirees unable or unwilling to live with the more volatile short-term movements of the stock market.

These choices aren't mutually exclusive. What's more, though guidelines like these make planning easier, life doesn't always go according to plan. If a bear market hits during retirement, for example, you may want to lower your spending based on the performance of your portfolio. A dynamic approach might take more work than simply withdrawing a fixed percentage of your portfolio every year, but it makes sense to stay as flexible as possible.

Step 3: Calculate how much you need to save and invest now
The final step is to start building a portfolio that will give you the cash flow you need in retirement. This involves figuring out your time horizon, projected savings rate and expected return on investments. Careful planning should give you a better idea of what to expect.

The bottom line
Most of us don't save and invest for decades so we can leave behind a nice portfolio. We intend to use our investments. The ability to spend with peace of mind in the early years of retirement is particularly important. By following a disciplined approach to retirement planning, you better your chances of enjoying a comfortable and rewarding retirement in which you're reasonably free to spend with confidence.

Next: Build Your Retirement Portfolio to Last

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided, including statistical simulations, are provided for illustrative purposes only and are not intended to imply future results you should expect to see. Past performance is no guarantee of future results.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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