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Financial Mistakes to Avoid: Running Out Of Money In Retirement

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Naaman Creative

Running Out Of Money In Retirement

Retirement is most people’s largest single financial goal they’ll have in their lifetime. One of the biggest financial concerns people have and a major financial mistake to avoid: running out of money in retirement. There’s a number of different factors that can play into someone running out of money in retirement. The two most common mistakes are unexpected health expenses and withdrawing too much from savings and investments.

Avoid Running Out Of Money In Retirement

Unexpected health expenses can be taken care of with the proper health insurance for those who are under 65 years old. Medicare supplement insurance is a great option for those over 65 years old. Additionally, the most commonly skipped type of insurance, long term care. If you have those checked off the list, you’re likely going to avoid running out of money in retirement because of health care expenses.

Taking too much money from the nest egg is a little tricker. If you’re someone that will be taking money out of your investments on a regular monthly basis, most studies show, if you take no more than 4% from your nest egg, that you are not likely to run out of money in retirement. The higher the percentage you take, the higher likelihood you have of running out of money.

Financial Mistakes to Avoid - Running Out Of Money In RetirementFinancial Planning For Retirement

A common financial mistake to avoid for retirement that I see far too often is when people take out much more money than what they need to live on. We will look at an example of why this is a bad idea.

The documented rate of returns of the last 25 years in the S&P 500 index (500 largest US stocks) is in the chart below. This example assumes a person retires at age 62 and lives until 87 years old. In this scenario, they take $50k/year from their $500k savings and investments from an all stock portfolio in the S&P 500 index.

Generally speaking, I’d suggest diversifying into more assets such as stocks, bonds, real estate, and alternative investments rather than just having everything held in stocks. However, for this specific example, we’ll keep it simple.

Running Out Of Money In Retirement Example:

Bob has a $500,000 IRA that he wants to take $50k/year from that money for the rest of his life. Here’s how that scenario would play out:

Year
S&P 500 Rate of Returns
Withdraw
Account Value
Start of 1996  $        500,000
1996 20%  $      50,000  $        550,000
1997 31%  $      50,000  $        670,500
1998 27%  $      50,000  $        801,535
1999 20%  $      50,000  $        911,842
2000 -10%  $      50,000  $        770,657
2001 -13%  $      50,000  $        620,472
2002 -23%  $      50,000  $        427,717
2003 26%  $      50,000  $        488,923
2004 9%  $      50,000  $        482,926
2005 3%  $      50,000  $        447,414
2006 14%  $      50,000  $        460,051
2007 4%  $      50,000  $        428,453
2008 -38%  $      50,000  $        215,641
2009 23%  $      50,000  $        215,238
2010 13%  $      50,000  $        193,219
2011 0%  $      50,000  $          61,837
2012 13%  $      50,000  $        111,837
2013 30%  $      50,000  $          95,388
2014 11%  $      50,000  $          55,881
2015 -1%  $      50,000  $            5,322
2016 10%  $      50,000 $          0
2017 19%  $      50,000  SOL
2018 -6%  $      50,000  SOL
2019 29%  $      50,000  SOL
2020 16%  $      50,000  SOL
2021 22%  $      50,000  SOL

Are You Running Out Of Money In Retirement?

Bob started off in the best timeframe in recorded stock market history in the late 1990s, which initially helped catapult his account. That is, until the negative years started to dwindle his savings away. In this example what did him in was 2008 because he was withdrawing such a high percentage of money and was never able to recover those loses. He could have avoided the biggest financial mistake: running out of money in retirement, but did not create a proper financial plan to do so.

If he hadn’t been taking as much money from retirement savings and investing this whole time, he would have avoided the financial mistake of running out of cash in retirement. Instead, at 81 years old he ran out of money. This is not the place you want to be at that age because I don’t know many 80 year olds itching to go to back to work.

If Bob instead took only 4% of the initial amount or $20k/year, this is what would have happened to his account value:

Year
ROR
Withdraw
Account Value
Start of 1996  $        500,000
1996 20%  $20,000  $        580,000
1997 31%  $20,000  $        739,800
1998 27%  $20,000  $        919,546
1999 20%  $20,000  $    1,083,455
2000 -10%  $20,000  $        955,110
2001 -13%  $20,000  $        810,946
2002 -23%  $20,000  $        604,428
2003 26%  $20,000  $        741,579
2004 9%  $20,000  $        788,321
2005 3%  $20,000  $        791,971
2006 14%  $20,000  $        882,847
2007 4%  $20,000  $        898,161
2008 -38%  $20,000  $        536,860
2009 23%  $20,000  $        640,338
2010 13%  $20,000  $        703,582
2011 0%  $20,000  $        683,582
2012 13%  $20,000  $        752,448
2013 30%  $20,000  $        958,182
2014 11%  $20,000  $    1,043,582
2015 -1%  $20,000  $    1,013,145
2016 10%  $20,000  $    1,094,461
2017 19%  $20,000  $    1,282,409
2018 -6%  $20,000  $    1,185,646
2019 29%  $20,000  $    1,509,249
2020 16%  $20,000  $    1,730,729
2021 22%  $20,000  $    2,091,489

In most cases, over time, people need more money because of inflation. $20k in 1996 was worth a lot more than $20k in 2021. So, let’s account for that with a 2.5% inflation rate on the amount of withdrawals each year:

Year
ROR
Withdraw
Account Value
Start of 1996  $        500,000
1996 20%  $20,000  $        580,000
1997 31%  $20,500  $        739,300
1998 27%  $21,013  $        917,898
1999 20%  $21,538  $    1,079,939
2000 -10%  $22,076  $        949,869
2001 -13%  $22,628  $        803,758
2002 -23%  $23,194  $        595,700
2003 26%  $23,774  $        726,808
2004 9%  $24,368  $        767,853
2005 3%  $24,977  $        765,912
2006 14%  $25,601  $        847,539
2007 4%  $26,241  $        855,200
2008 -38%  $26,897  $        503,327
2009 23%  $27,569  $        591,523
2010 13%  $28,258  $        640,163
2011 0%  $28,944  $        611,219
2012 13%  $29,668  $        661,009
2013 30%  $30,410  $        828,902
2014 11%  $31,170  $        888,911
2015 -1%  $31,949  $        848,073
2016 10%  $32,748  $        900,132
2017 19%  $33,567  $    1,037,590
2018 -6%  $34,406  $        940,929
2019 29%  $35,266  $    1,178,532
2020 16%  $36,148  $    1,330,949
2021 22%  $37,052  $    1,586,706

What If I Run Out Of Money In Retirement?

What If I Run Out Of Money In RetirementIf someone lives long enough and is taking too much from their portfolio from the beginning, this can be a 1 way ticket to running out of money in retirement. Taking around 4% from your retirement savings is a safe financial model to reference. Withdrawing less than 4% will likely ensure you will not run out of money in retirement. The numbers in the S&P 500 include some of the best returns of the late 90s and 2009-today, but it also includes the devastating drops in 2000-2002 and 2008.

For those that plan on being around for a while, stocks can be a great tool to help outpace inflation and grow an account balance. However, long timeframes of down markets have historically happened during 30 year stretches in the stock market. So, just because the stock market is riding high doesn’t mean you should now take all those gains. Your account balance is likely to need those gains down the road in order to offset a drop in stocks similar to what happened in 2000-2002 and in 2008.

Retirement Financial Planning

Less is more when it comes to withdrawing money in retirement. Taking too high of a percentage of your portfolio compounded with stock market fluctuation can demolish a retirement plan. From the example above, Bob needs closer to $50k/year. So, his financial retirement options would be to work a part time job that can make up the difference or wait longer to retire. There’s no magic answer to growing investments accounts. Real financial return takes time and consistency. There are no short cuts with either of them. Withdrawing around 4-5% annually, combined with a diversified portfolio (meaning not all stocks), is a tested method to making sure your money out lives you.

Start planning your finances for retirement today by calling me directly at (609) 439-1687 or sending an email to dan@clientfocusedfin.com. You can also send me a message directly from the Contact page.