Annoying Real Life Math Problem

[livingdeb]

Given:

a) You should save at least 10% of your income for retirement and
b) To be sure of not outlasting your money, you should withdraw no more than 4% per year and
c) some simplifying assumptions,

Conclude:

You need to save for 40 years.

Comments

[llcoolvad.livejournal.com]

Math sucks. Add to that I've only been saving for about 4 years, and I'm already 42, and conclusion: I'm never retiring ever...

...although currently i'm saving 15% into my 401k and will be raising that next month to 17%. Or so. But I still think I'm doomed. At least I'll be able to cut down to part time... ?? maybe!

[livingdeb.livejournal.com]

So, you're set to retire at 78. Lots of people live to be older than 78. That's a lot sooner than never ever.

But wait! Assuming 10% the first 3 years, 15% the fourth year, and 17%
every year after that, I now conclude:

You can retire at age 71.5.
Or you can cut to half-time (4% of your investments = half your income) at 63.

[(Anonymous)]

rvman here: Yes, at 10% savings, a long run return of 7% above inflation or so, and the 4% withdrawal rule, you need to save 40 years. Or, if you save 20%, that becomes about 30 years. At 30%, that is 25. If you can up your income and maintain a stable standard of living, you can save the surplus.

Of course if you are like me, and think that 7% above inflation is optimistic given the current demographics of this country, you may need 15% just to get to 40 years. I'm thinking 5-6% above inflation - a nominal return of 8% or less - may be more realistic long run for the next 20 years or so, given that there will be a lot of boomers retiring and starting to sell off risky assets like stocks, in favor of safer bonds. This can't help but dampen the annual return stocks give.

The big problem is the difficulty of playing catch-up. Half of your retirement income is gained in the last 9 years of the 40 year program - if you start at 30, you lose 5 years if you want to retire at 65, and you come up 30% short - you need to be saving 15%, not 10%, for the rest of your working life just to make up that lost five years. If you start at 40, you need to save the 30% mentioned above to make it a 25 year program.

If anyone is confused about the 4% rule, it comes from the necessity of having a buffer for inflation - if you can earn 5% nominal returns (a reasonable return on the sort of very safe stuff a retiree should have her wealth in), and withdraw 4% in the first year, with a 2.5% inflation rate, you actually slightly increase or maintain your nominal wealth for 20 years of retirement, and then spend it all down to zero over the next 20 years. Most of us won't live 40 years into retirement, so that is a safe approach. The earlier you want to retire, the smaller that "4%" has to be - if you retire at 50, using 4% is taking a big risk, since your probability of living to 90, or seeing lower-than expected returns, is reasonably high. You need a bunch of years of 'buffer' wealth to protect against recessions, higher-than-expected inflation, high medical expenses, etc.

All of this neglects Social Security, which is a reasonable assumption if you want to retire early - you won't have that income until you are in your mid-60s at best, even later if you make reasonable assumptions about the future politics of SS. You don't want to be burning too much of your wealth early in retirement, just to replace social security. SS is at best a supplemental source of income, anyway - many of us may not see much more than a quarter or so of our pre-retirement income from it - proverbial dog-food money. You can burn it just with medical expenses, whether that is medi-gap insurance or medicare co-pays.

Or you can just go with the logic that age 65 was a reasonable retirement age when we lived 70 years or so on average, but now that we can live 90 or more, it is unreasonable to expect 25+ years of leisure, unless you were extremely thrifty and worked the high-stress, high-hours, high-pay jobs. You can solve a lot of problems in retirement math by working to 70.

[livingdeb.livejournal.com]

Okay, what if I save 150%? (Fun with bad math.)

I thought the 4% thing was more like assume that returns are 7%+ and inflation is 3%+. You have to leave that 3%+ in so that your base doesn't change (ever) and so that only leaves you 4% to withdraw. There's no "and then spend it all down" part.

However, the experts say to calculate the 4% based on how much you had the very first year, and then pull out a little more than that each year due to inflation, and so long as the market doesn't plummet during your early years, you'll probably be okay. Because people are too inflexible (living paycheck to paycheck the way we so adore) to have their actual incomes go up and down with the market.

**

Yes, I do think that eighty is the new sixty-five, but I still don't want to wait that long if I can manage it. It's one of my very few expensive goals in life.

Simpler solution

[(Anonymous)]

Or couldn't you just plan to die earlier?

(sally)

Re: Simpler solution

[livingdeb.livejournal.com]

So true. If I knew I were dying sometime within the next five years I could retire right now!

But then as those years went by, I might find the warm glow of easy math fading a bit.