Deconstructing Pete’s Retirement Calculator – Part TWO
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What distribution rate would you like to use in retirement income planning?
The distribution rate is the amount (as a percentage) that you will withdraw from your savings each year in order to meet your expenses. And the “right” answer to this question has been a constant topic of conversation in financial planning circles for several years. 4% has been the standard for quite a while. 4% is an estimate, based on decades of evidence, of the amount that you could withdraw from your savings each year and feel very confident that your nest egg would last through a typical 30-year retirement.
Now, however, after years of persistently low interest rates, planners are re-thinking the “4% rule” and feel more comfortable advising a 3.5% or even 3% distribution rate. Others feel that this is overly simplistic as it does not account for the fact that many people will spend more in the early years of retirement, but less later on (barring major medical expenses). As well, a person with a pension income may feel more confident with a higher distribution rate as they are less worried about their savings running out.
It may be impossible to ever answer this question once and for all with a single number that works universally for everyone. However, using 3.5% as your distribution rate would seem to be a prudent start. And perhaps the most important take-home message is that while the total size of your portfolio may seem like a grand number, it needs to last over many years. Thinking carefully about your distribution rate allows you to see more clearly whether or not the amount you have saved is sufficient to meet your needs.
Gross Retirement Income.
We have just about arrived at the bottom line. This is the amount of annual income before taxes that your savings will produce in the year that you retire. Is it enough? Be sure to consider inflation. If your result is $50,000 but retirement is 20 years away, that is the equivalent of only $28,000 today (assuming 3% inflation). This is where you will start to think about other sources of income, such as Social Security or a pension. The question of whether or not this figure is “enough” will need to be answered in the context of all of your retirement streams of income.
Net Retirement Income.
Finally, taxes. 25% is a pretty good estimate of the amount that you can expect to pay in taxes, combining both state and federal obligations. That said, if some of your retirement savings are in a Roth account, this income will not be taxable. Consider what portion of your retirement savings are non-taxable and adjust for that. And if you retire to a state that does not have a state income tax, you can adjust the percentage downwards for that as well.
And there you have it! As always, reach out to us when you need help making this all make sense!