Rules of thumb on retirement spending
How much are you likely to want for regular spending in retirement?
Realistically, many of us think more in terms of ‘How much will I be able to spend in retirement?’ Here are some easy ways to get an idea of that. We’ll start with a very simple calculation.
Rule of thumb 1: If you retire at 65 with X hundred thousand dollars, you can spend $X a week
For example, if your savings total $100,000, you can spend $100 a week above NZ Super. If you’ve saved $50,000, you can spend $50 a week, and if you’ve saved $500,000, you can spend $500 a week.
You’ll be spending returns earned on your savings, but also gradually eating into the savings themselves. But all the while the remaining savings are growing, with compounding returns.
Under this formula, your savings will probably last as long as you do. But if you live into your late eighties or older, you probably won’t have a huge amount left over.
Want something a bit more sophisticated? Members of The Society of Actuaries – who are experts on money and statistics – have come up with some calculations about how far a retirement savings sum will go if you use up most or all of the money.
I’ve chosen two to look at here, which I’ve called Rules of Thumb 2 and 3. If you want to see two others, or read more about the assumptions made, see the rules of thumb [external link] published by the New Zealand Society of Actuaries [external link].
Rule of thumb 2: If you retire at 65, each year you can spend 6% of your savings at the start of retirement
If you save $100,000, you could spend $6,000 a year – or $115 a week, above NZ Super. With $50,000 it would be $3,000 a year or $58 a week, and with $500,000 it would be $30,000 a year or $577 a week.
If you invest your savings in a conservative fund – in or out of KiwiSaver – your money will almost certainly last until your mid eighties. And, depending on future returns, it may last until you’re 90 or even 100.
You might have noticed that Rule 2 is a bit more generous than Rule 1.
An important point to note about both rules: If you retire after age 65, you will be able to spend more per week. That brings us to a third rule, which works regardless of your retirement age.
Rule of thumb 3: Divide your money by the years you want it to last
Say you retire at 70 and you want your money to last until you’re 90 – after which, NZ Super should be enough.
In the first year, spend 1/20 of your savings, in the second year 1/19, and so on. In the second-to-last year you’ll spend half of what’s left of your savings, and in the final year you’ll blow the lot and switch to NZ Super only – although of course you could choose instead to spread out your spending at that stage.
Unlike Rules 1 and 2, you won’t know in advance exactly how much you can spend each week. That will vary a bit depending on the returns you earn on your savings in the meantime. But, also unlike the other two rules, you do know exactly how long your savings will last.
What about inflation?
How does inflation affect the rules? Good question.
Under Rules 1 and 2, you’ll withdraw the same amount each year, but inflation will gradually decrease how much you can buy with that withdrawal.
But NZ Super – your other source of income – currently rises by more than inflation, and it seems unlikely it will rise by less than inflation in future. In any case, spending often decreases as people get older.
Rule 3 is much more inflation-proof. Because your savings will usually grow over the years, you will generally have more to spend each year.
I say ‘usually’ because if you have some of your savings in riskier investments – perhaps the savings you don’t expect to spend for at least ten years – and the markets fall, you will have less to spend in the following year. More about how to invest your savings in retirement shortly.
Which rule of thumb should you use? It depends partly on the inflation issue, which favours Rule 3 if you want to spend more each year. But Rules 1 and 2 give you more certainty about your spending amount.
Given that you spend a bit less under Rule 1 than Rule 2, you’re more likely to leave an inheritance (apart from your home), but you have a bit less fun along the way.