When Is It Time? (and Other Hard Questions About Retirement)

Jim writes in:

How do you know when it is time to retire? Also how should you invest in retirement? Advice seems to be to go more conservative with investments but what if you’re retired for a long time?

Jim is actually an old friend of mine who has read The Simple Dollar almost since its inception. He asked me the other day whether he could submit a mailbag question and I said, “Of course, but try to keep it short because short mailbag questions are more readable,” and then he dropped that on my lap. It’s definitely a short question and a very good question, but it goes far beyond what I can answer in a few paragraphs in the mailbag.

So, let’s open up this can of worms. As is usually the case, I’m going to keep my response in simple terms, but you can keep going on the specific points raised here with further reading for pretty much as long as you can imagine.

When Is It Time to Retire?

There is no specific age at which anyone should retire. Rather, a person should retire at the point where they can live a life they’re happy with for a very long time using a combination of Medicare, Social Security, a slow drawdown of their retirement savings, and any pensions or other financial assets they might have.

In my eyes, the easy answer for a retirement age, if you must have a number, is 67. The reason for that is that it’s the age at which people can begin drawing full Social Security benefits. If you start drawing benefits prior to that age (except in rare circumstances), you’re going to miss out on monthly benefits for the rest of your life.

If you can retire before then and use your retirement savings to get you to age 67 before drawing Social Security, that’s a reasonable move, too.

Another factor to consider is how much you have saved for retirement. In general, you should withdraw at most 4% of your total savings per year. If you withdraw more than that, you run a strong risk of running out of money before the end of your life, leaving you in difficult circumstances. Social Security alone is very difficult to live on, and if you run out of other assets, you’re going to be in a challenging spot. In my own plan, I intend to withdraw only 3% of my retirement savings balance per year.

To put that into context, imagine that you have $100,000 saved for retirement. It might seem like a nice amount at first glance, but if you’re only withdrawing 4% of it a year, that’s only $4,000. 3% is only $3,000. A year. Of course, that’s a supplement to Social Security, but you’re looking at monthly amounts on the order of $250 if you’ve only got $100,000 saved. $250 per month in addition to Social Security still isn’t a whole lot.

So, here’s a quick formula: Take your current retirement savings and divide it by 30, then add your estimated current Social Security benefits to that number. Can you live on that amount? If you can do so easily, you’re likely ready to retire whenever you feel like doing so. If it’s close, you can start thinking about retirement but should wait a couple of years to pull the trigger and really research the question. If it’s nowhere near close, you’re nowhere near being able to retire without some major lifestyle changes or taking on a new job (which isn’t really retirement, after all).

It’s for this reason that I encourage people to start saving for retirement as early as possible. The earlier you save for retirement, the more years that compound interest has to work in your favor. Saving $1,000 at age 25 has more impact on your retirement than saving several thousand at age 50, simply because of the power of compound interest. Save now if at all possible.

How Should I Invest in Retirement?

The second part of Jim’s question considers how a person should manage their investments once they’re retired. As has been noted many times on The Simple Dollar, it’s wise to invest strongly in aggressive investments before retirement and even up until close to retirement, but the standard advice is to start moving into more conservative investments at some point. How exactly should you do this, though?

This is a subject where you’re going to get a lot of different opinions. I’ve heard varying ideas on this subject from different investment advisors and different investing manuals and I’ve come to the conclusion that there is no “best” answer, because the “best” answer involves predicting both the length and quality of your lifespan along with the future of various investment markets.

However, you “can” come up with a best strategy if you make a few assumptions.

For starters, the longer you assume that you’re going to stay alive after you retire, the lower your withdrawal rate should be and the higher the proportion of your retirement savings should be in aggressive investments. For example, let’s say you retire at 65 and you believe you’ll live until you’re 90. That means you have 25 years to go. In general, investment goals that are further than ten years down the road should be invested for in an aggressive manner, so somewhere around 60% of your retirement should be aggressively invested in this picture (as 60% of the remainder of your life is beyond the 10 year mark).

How do you decide that? Well, for me, the decision’s easy – I prefer to believe I’m going to live as long as possible and, at the same time, I don’t mind it too much if my kids and grandkids have what’s left behind if I die sooner than that. For me, it’s preferable to know that I have money to live on for many more years than to chase some dream of “spending it all before I die and leaving this world with nothing.” That’s too big of a risk. If I assume that I’m dying when I’m 75 and spend accordingly, I’m going to have a miserable decade of life when I hit 80.

My strategy when I retire is to keep what I’ll need to withdraw in the next ten years in something safe and put everything else into something aggressive. If I need $20,000 a year from my retirement accounts, I’ll put $200,000 in something safe and everything else will be put into something aggressive. Then, I’ll rebalance once a year to make sure I have an appropriate amount in safe investments. If I decide I need more money per year, then more will go into the “safe” investments.

This way, I know that I’ll have the next ten years covered between retirement and Social Security, and by having everything else in aggressive investments, I know that I’m doing the best I can to build value for the long term in case I live to see 100 or more.

There are other factors to consider here, of course. What will the future of the stock market look like? What will the future of tax rates look like? What will the future of rules on retirement accounts look like?

I don’t know the answers to those questions and neither does anyone else. The best we can do is plan based on what we do know. What do we know? We know what the stock market has historically looked like. We know the current laws surrounding 401(k)s and Roth IRAs and how they work and how Congress is very unlikely to mess with current accounts in any significant way.

Final Thoughts

All I can do is plan ahead according to what I currently know and what history has shown me. I know that the lifespan of people in my family is somewhat above average (provided that accidental death doesn’t take them, of course). I know that the stock market, over its history, has gone up pretty steadily over the long term but with lots of fits and starts. I know what retirement saving options are available to me. I know what a lot of financial advisors have said over the years regarding retirement planning.

Putting all of that together, I have a plan that I intend to follow that makes a lot of sense to me.

Of course, you should do your own homework. I highly recommend starting with The Bogleheads’ Guide to Retirement Planning, which is a wonderful guide that covers a bunch of retirement topics. There are many great books out there on retirement topics, and you should continue your reading with some of the selections available at your local library. Just avoid ones with sensationalist titles like “Millionaire by 28” and so on.

Good luck.

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