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: Why you should retire with more money than you need

I’m frequently asked some variation of this question: Can I afford to retire? The question seems simple, but it’s trickier than you might think.

The simple answer is: It depends on how much you need from your investments every year and how much your portfolio is worth.

In my view, the best way to retire is with as much money saved as possible. In this article, I argued that many people could effectively double their retirement income by postponing it five years.

How you invest can make a huge difference as well. You’ll need to have at least some of your money in equities, and if history is a good guide, you’re likely to do better if you diversify your equities beyond the popular S&P 500 index
SPX,
+1.61%
.

And no matter how much or how little money you have, you should structure your withdrawals thoughtfully.

Read: Three things to take care of when you retire—your future self will thank you for it

Let’s assume that in addition to Social Security and other sources of income, you need $40,000 a year from your portfolio, and that anything less than that will likely leave you feeling pinched.  

In that case, if you have a portfolio worth $1 million, your chances of success are favorable. But more is certainly better, because it lets you take flexible distributions, a fixed percentage of each year’s portfolio value.

That way, when your investments have done well, you can take out a bit more. And when the market has been unkind, you can tighten your belt a bit.

Read: I have a government job and a small pension. I’m planning to work a few more years. Should I file for Social Security now or wait?

If you can comfortably start your retirement by taking out 4% of your portfolio’s value, you can let the other 96% remain invested. One year later, you can do it again.

If you start with more money than you absolutely need, you’ll have more money to spend, more money to leave to your heirs, and more peace of mind.

Moreover, depending on how much “extra” savings you have, you might be able to safely take out 5% each year instead of 4% — giving you a really nice cushion.

Now let’s roll up our sleeves and study some numbers. (My regular readers won’t be surprised to learn I have some tables to share.)

Each table in this link tracks the hypothetical results of a given investment portfolio year by year, from 1970 through 2021, based on a particular rate of withdrawal.

This lets you see how that portfolio held up with the rise and fall of the markets as you took money out. Let’s walk through a couple of scenarios.

Start by scrolling down to Table E1.4, and look for the three columns under the heading “60% S&P 500 Fund / 40% US Bonds.”

These columns assume you had 60 % of your portfolio in the S&P 500 and the other 40% in bond funds, and that you began retirement with $1 million and took out $40,000 for your first year. After that, each year you withdrew 4% of the ending balance from the prior year.

You’ll see that this plan gave you less than $40,000 in 1975, after a particularly unproductive year in the stock market. But every subsequent year through 2021, you had more than the $40,000 you needed.

Still, inflation was a real thing in the 1970s and 1980s, and those withdrawal numbers look better than they really were.

However, if you had started retirement with $1.5 million instead of $1 million, you could multiply every one of those withdrawal numbers by 1.5. So in that bad year of 1975, you would have withdrawn $54,414.

That’s why I preach and teach: Save more than you must.

Now let’s see what happens with a slightly different mix of equity funds. Until now we have assumed you had all your equities in the S&P 500.

However, other combinations have produced higher returns, and I believe they will continue to do so over the long run.

One excellent alternative is a four-fund U.S. combination made up of equal parts of the S&P 500, large-cap value stocks, small-cap blend stocks, and small-cap value stocks.

You can see how that combination would have fared starting in 1970 in Table E9.4, which gives the same information as the table we looked at earlier.

If you follow the same columns, you’ll see that a 60/40 portfolio supplied substantially more than the $40,000 that you needed.

Investment returns are not within your control. But you can choose how much of your portfolio that you withdraw each year.

Table E8.5 shows distributions starting at $50,000. In this scenario, after 1975, you were always well above $40,000.

Could you have succeeded by withdrawing 5% per year without diversifying beyond the S&P 500?

As you can see in Table E1.5, for this particular set of years, the answer appears to be yes. But taking 5% instead of 4% has two potential downsides.

First, if you are unlucky enough to retire right before a string of bum market years, the higher distributions will deplete your portfolio faster, and it could take you longer to fully recover.

Second, if you live to a really ripe old age, you may have less money available during your final years and less to leave to your heirs.

Like almost everything else about investing, planning your distributions involves important trade-offs:

Are you willing and/or able to delay retirement a few years to build up your nest egg?

Do you care more about spending power in your early retirement years, or more about how much you’ll leave to your heirs?

How long do you expect your retirement to last?

Are you comfortable “cutting it close,” or would you rather have a wide margin for error?

Do you want to stick with the S&P 500, or are you willing to diversify into other asset classes?

The hard truth is that there’s no single “right answer” for every situation.

But I’m sure of this: You won’t go wrong by retiring with the comfort and security of having abundant savings.

For more, listen to my podcast, “Flexible distributions: A great luxury in retirement.”

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways to Supercharge Your Retirement. Get your free copy.

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