Retirement is a significant milestone, and for many, it comes with a pressing question: How much can I safely spend without the risk of outliving my savings? This concern is common among retirees, regardless of the size of their nest egg. In this post, we’ll explore a detailed case study of a couple preparing for retirement with $2 million in savings. We’ll also delve into why traditional spending strategies like the 4% rule may not be the best approach and how a more dynamic spending strategy can help you enjoy your retirement years to the fullest.
Meet Jane and John, a couple who have worked hard and saved diligently throughout their careers. As they approach retirement at age 65, they have amassed a net worth of $2.8 million, including their primary residence valued at $750,000. However, because their home isn’t a liquid asset, we’ll focus on the $2 million they have in accessible financial assets.
Their portfolio is diversified across various accounts:
Jane and John are currently earning $110,000 each per year, but they plan to retire next year. Their goal is to spend $120,000 annually, or $10,000 per month, in retirement. This target is a bit higher than what traditional retirement rules like the 4% rule would suggest, leading them to seek a more tailored strategy.
The 4% rule has long been a staple of retirement planning. It suggests that retirees can safely withdraw 4% of their initial retirement portfolio each year, adjusted for inflation, without running out of money. For Jane and John, this would mean withdrawing $80,000 annually from their $2 million portfolio. However, this conservative approach often results in retirees ending their lives with more money than they started with, leading to potential underspending during their most active years.
While the 4% rule is a safe strategy, it might not be the best fit for retirees like Jane and John who want to maximize their spending in the early years of retirement when they can enjoy it the most. This is where dynamic spending strategies, such as the guardrails approach, come into play.
The guardrails approach is a dynamic spending strategy that adjusts your spending based on the performance of your investment portfolio. Instead of sticking to a fixed withdrawal rate, this method allows for increases and decreases in spending depending on how well or poorly your investments are doing. This flexibility ensures that you can spend more in good years while making small adjustments during downturns to avoid depleting your nest egg too quickly.
The software we use at Spark Wealth Advisors, Income Lab, is designed to implement this guardrails approach effectively. Unlike more traditional financial planning tools that focus on general projections, Income Lab hones in on retirement spending capacity based on your assets, Social Security income, and life expectancy.
For Jane and John, their starting spending amount using the guardrails approach is $155,000 per year, which is significantly higher than the $80,000 suggested by the 4% rule. This amount can fluctuate depending on their portfolio’s performance and includes social security income of $3200/mo for John and $3000/mo for Jane:
These adjustments are not frequent but are crucial for maintaining a sustainable withdrawal strategy. The guardrails approach allows Jane and John to enjoy more of their savings earlier in retirement without the fear of running out of money later in life.
One of the key benefits of the guardrails approach is its flexibility. It accommodates changes in market conditions and personal circumstances, allowing retirees to adjust their spending without drastically altering their lifestyle. For instance, Jane and John could choose a lower initial spending amount with a lower chance of needing to adjust it, or they could start with a higher amount and accept the possibility of occasional adjustments.
This flexibility is essential because it aligns with the natural spending patterns of retirees. Research shows that retirees tend to spend less in the middle years of retirement and then increase spending later in life due to rising healthcare costs. The guardrails approach, with its ability to adjust spending based on actual needs and market performance, aligns well with these trends.
Rather than relying solely on projections which may or may not come true, we also stress test retirement plans against historical scenarios. For example, how would Jane and John’s plan have held up during the 2008 financial crisis?
Using IncomeLab, we applied their plan to the financial conditions of the Great Recession of '08. Starting just before the market crash in November 2007, Jane and John would have had to decrease their spending slightly as their portfolio value dropped, but as the market recovered, their spending could have increased, ultimately allowing them to maintain a comfortable lifestyle throughout the crisis.
This kind of stress testing provides peace of mind for retirees, showing them how their plan would perform under various economic conditions and helping them prepare for the unexpected.
The goal of retirement planning isn’t just to ensure that you don’t run out of money—it’s also about making sure you enjoy the fruits of your labor. By using a dynamic spending strategy like the guardrails approach, retirees can strike a balance between spending confidently and preserving their nest egg for the future.
In Jane and John’s case, the guardrails approach allows them to spend more in the early years of retirement, when they are likely to be more active and able to enjoy their money. At the same time, it provides a safety net that adjusts their spending if market conditions take a downturn, ensuring they won’t outlive their savings.
Every retiree’s situation is unique, and there is no one-size-fits-all approach to retirement spending. While traditional strategies like the 4% rule provide a solid foundation, more personalized approaches like the guardrails strategy offer greater flexibility and the potential for higher spending in the years when you can enjoy it most.
At Spark Wealth Advisors, we’re committed to helping our clients retire with confidence and clarity. If you’re approaching retirement and wondering how much you can safely spend, consider a dynamic spending strategy that adjusts to your needs and the market’s performance. Contact us today to learn more about how we can help you create a retirement plan that maximizes your spending potential while protecting your nest egg.
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