If you're nearing or in retirement, one of the biggest questions you likely find yourself asking again and again is, “How long will my money last?” The answer will determine whether you can live comfortably in retirement or possibly struggle to make ends meet.
Fortunately, you don't need a crystal ball to figure out how long your money will last in retirement. You just need to do a few simple calculations. Follow these steps to get a good idea of whether you have enough resources to support yourself or whether you need to make changes to ensure your money will last.
Step 1: Figure out how much is coming in vs. going out
When trying to determine whether you will have enough money in retirement, you should first figure out if your monthly spending exceeds income from reliable sources such as Social Security and a pension, says John Cooper, a Certified Financial Planner™ professional with Greenwood Capital Associates. Review your bank and credit card statements to add up expenses then subtract them from the amount you are receiving (or will receive) from Social Security or a pension.
If your guaranteed sources of monthly income cover your expenses, you don’t have too much to worry about, Cooper says. However, if your monthly spending exceeds your guaranteed sources of income, you need to figure out what other sources of income you can draw on to cover costs.
[ Read: A Guide to Social Security Benefits ]
Step 2: Determine how much you have in savings
If you need to rely on retirement savings to supplement guaranteed sources of retirement income, you need to be sure that you have enough set aside and that your savings are invested properly.
Savings accounts, money market accounts, savings bonds, certificates of deposit and fixed annuities are low-risk places to keep your cash. However, low risk equals low returns. That means if your money is in any of these types of accounts or savings instruments, it won’t grow much over time. If your rate of return doesn’t keep up with the rate of inflation, your purchasing power will decrease and your money might not go far enough in their retirement.
If your money is invested in stocks or stock mutual funds, there’s more opportunity for growth. There’s also the risk that the value of your portfolio could drop dramatically during stock market downturns. To keep risk in check while maintaining the potential for growth, financial advisors often recommend that retirees have a portfolio with a mix of stocks, bonds and cash.
Step 3: Calculate your withdrawal rate
To figure out how long your savings or investments will last, you need to know the rate at which you are withdrawing money. Don’t worry: This doesn’t involve calculus or even advanced algebra.
Go back to Step 1. How much does your monthly spending exceed their guaranteed sources of income? Let’s say you’re withdrawing $1,000 a month from savings or investments. That’s $12,000 a year.
Now, divide that number by the total amount you have in savings. If you have, say, $100,000 in savings, the calculation would look like this: 12,000/100,000=0.12. Multiply that by 100 to get the withdrawal rate: 12%.
If that $100,000 is in a savings account earning just 0.1% and you are withdrawing 12% a year, you would run out of money after eight years and five months. If your money is invested in stocks and earning 7% annually, it would last 12 years and three months with a 12% withdrawal rate.
Bankrate has a savings withdrawal calculator you can use to figure out how long your savings will last.
Step 4: Make sure you aren’t withdrawing too much
Traditionally, a 4% annual withdrawal rate has been seen as a safe withdrawal rate. “If you’re drawing 4% or less of the value of an investment account year over year, it was highly unlikely that you would outlive that investment account,” Cooper says.
That rate is based on the assumption that withdrawals would last for 30 years and come from a portfolio that was invested 50% in stocks and 50% in bonds. Cooper says many advisors now assume that a 3% withdrawal rate is a safer bet to insure that retirees’ money will last.
Of course, there are a lot of variables that can come into play that can affect the rate at which you should be withdrawing money from savings or investments: your expenses in retirement, your portfolio composition, your rate of return, your tax rate and your life expectancy. However, if you are withdrawing much more than 4% a year from savings, Cooper says you could be headed for trouble. “When you start getting up to 10%, you’re really exponentially withdrawing money that is going to cause it to run out,” he says.
[ Read: 12 Ways Retirees Can Save Money ]
Step 5: Find Ways to Make Your Money Last Longer
There are a variety of ways you can boost your income in retirement. Some require taking action before you retire.
Delay claiming Social Security benefits: If you haven’t retired already, you can boost your Social Security benefits by working longer and waiting to claim your benefits past your full retirement age.To receive your full benefit, you must wait until your full retirement age of 66 to 67 (it varies depending on birth year). For each year you wait from full retirement age until age 70 to claim benefits, the amount of your benefit will increase by 8%, Cooper says. Waiting to claim benefits “could make the difference between struggling on Social Security to getting by,” he says.
Choose the right pension payout option: Pension plans typically offer a variety of payout options: a lump-sum payment, a single-life option that produces a stream of lifetime payments that end when the pension recipient dies, and a joint and survivor payout that will continue to provide payments for a surviving spouse when the pension recipient dies. If you're married and only one of you has a pension, choosing the single-life option will produce bigger monthly payments but will leave the surviving spouse with nothing. A joint and survivor payout will reduce the monthly payment but ensure the surviving spouse receives 50% to 100% of the monthly payment the other spouse was receiving.
Get the right asset mix for retirement savings. As the withdrawal rate illustration above shows, your savings can go further if the money is invested in assets with a higher rate of return than what a standard savings account offers. That doesn’t mean all of your money should be in one or two stocks. Investing in an index fund that tracks the performance of a major stock index along with bonds or bond funds and keeping some cash in a money market account or savings account can reduce overall risk while providing some opportunity for growth.
Downsize sooner rather than later: If you are thinking about moving to a smaller house or apartment, do it sooner rather than later. Not only will you save money on house payments, but also your property tax bill and utilities will be lower. Then you can put that extra money toward paying down debt or increasing your savings.
Consider a reverse mortgage: You may be able supplement their income with a reverse mortgage if you are 62 or older and own your home or have paid off most of your mortgage. The money from a reverse mortgage (also known as a Home Equity Conversion Mortgage) can be received as a lump sum, in monthly payments or as a line of credit. Reverse mortgages aren’t ideal for everyone because they have high fees and will essentially leave you without a home to pass on to heirs (unless your heirs want to pay off the loan). However, they’re helpful for people who need extra income but have no desire to leave their home, Cooper says.
The best bet is to to hire a financial advisor who can calculate how long your money will last and help you create a solid retirement income plan to stretch the resources you have as far as possible. You can find a financial advisor through the Financial Planning Association and the National Association of Personal Financial Advisors.
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