Do you or did you have one million dollars in retirement savings when you retired?
The Basis for the “One Million Dollars” Rule
When it comes to the “you need one million dollars in retirement savings” before you can retire mantra, there are two rules that retirement planners frequently bring up. One rule estimates how much you will need to save for retirement. This rule states that you should multiply by 25 your desired annual income. So, if you want to withdraw $40,000 a year from your retirement portfolio, you will need to have saved $1 million ($40,000 x 25 = $1 million).
Well, if you are a visitor to my blog, you are either retired/nearly-retired. Thus, if you did not save $1 million dollars prior to retiring, the above rule is a little too late!
The other rule is the 4 percent rule. This rule states you can safely withdraw 4 percent a year from your retirement portfolio for an income of $40,000/year.
Example: Assume you need $80,000 per year. First, look at any pensions o Social Security benefits that will provide a source of income. If a pension provides $20,000 per year and Social Security provides an additional $20,000 per year, then your portfolio would need to provide an extra $40,000 each year. To avoid running out of money, you should probably start by withdrawing 4% a year or less with an annual inflation adjustment. To generate $40,000 per year at 4% requires a minimum portfolio size of $1,000,000.
Why 4 Percent?
The 4 percent rule assumes that, over the long term, your stocks will produce annualized returns of roughly 7 percent. However, because inflation tends to erode the value of the dollar at roughly 3 percent per year, your “real return” — after inflation — will be about 4 percent. Thus, you can safely withdraw 4 percent a year.
Some experts maintain the above two rules are not conservative enough. They claim it’s not realistic to expect long-term annualized 7 percent returns for retirees whose portfolio are primarily in bonds and cash. They argue for a 3 percent withdrawal from your portfolio, or savings of 33 times your annual withdrawal rate.
While no one can reasonably dispute that you should have substantial savings by the time you retired, in my next post, I explain why I chose to retire from full-time work with less than one million dollars.