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When you retire is one of the most significant decisions of your life. It’s also one of the toughest ones to make. Your savings’ lifespan will depend on multiple factors, including the economy, inflation, and many others, which aren’t under your control.

As we go through this article, we’ll discuss estimates, overall trends, and good-faith guesses based on how stocks, bonds, and retirement accounts have performed over the past century. Nothing is inevitable, but you can set a baseline from which to form your overall plan.

The Basic Rule

How long your retirement savings will last depends on the following factors:

Some of these will change in real time, but you can put together an estimate in three steps.

Example: Mr. & Mrs. Tran

Imagine a 50-year-old couple looking toward retirement. They want to know when they can retire. We’ll use their income and reliable projections to walk you through this process step by step.

Step 1: Estimate Annual Income

Multiply your savings by your expected return from those investments. Add to that total any reliable additional income you anticipate, such as income from rental properties, pension payments, or a passive income system. Deduct from that what you estimate you will pay in taxes for that income. That’s the amount of money you can spend each month, assuming the return remains consistent over the year.

Mr. & Mrs. Tran

The Trans have $200,000 in retirement savings. At an annual interest rate of 6%, they would get $12,000 per year in returns. Their Social Security payments will pay a total of $2,000 per month. They’ll also reliably get $1,000 each month from a beach house they rent when they’re not using it.

That’s a total of $4,000 per month in retirement income. Estimating an average tax rate of 15%, they would have $3,400 to spend after taxes, or $40,800 per year. If they can live on that amount, they could retire today.

Elderly couple dancing in the kitchen

Step 2: Estimate Annual Expenses

Estimate how much money you want to spend during retirement. This is a complicated formula, but you can start with your annual budget now, minus retirement contributions. Many experts suggest you deduct 10 to 30% from that number because going to work costs money. Run the numbers as best you can.

Consider any downsizing you plan to do, like moving into a smaller home, paying off debts, or reducing certain luxuries. For example, many retirees aim to retire on or about the time they pay off their mortgage.

Mr. & Mrs. Tran

The Trans have been living on $120,000 per year. Of that amount, they save about $1,500 each month toward retirement. That, plus a 10% deduction of $12,000, totals $30,000 they won’t be spending after retirement. That leaves $90,000 per year in income.

However, they stand to pay off their $2,000-a-month mortgage in six years, and their oldest child graduates from college in two years, eliminating the need for $18,000 in tuition and financial help they’ve been giving her. That’s another $42,000 in annual expenses they won’t need to pay for. So, they will probably live on $48,000 per year.

Step 3: Adjust and Project

Begin this process by comparing the results from steps one and two. If your estimated annual expenses are smaller than your estimated annual income, your retirement money will theoretically last as long as you need it (barring unforeseen disasters). If the expenses are higher than your income, you have three options:

  1. Put off retirement for a few years until you have more money saved or more passive income.
  2. Downsize further, reducing your expenses until they are lower than your projected income.
  3. Choose to take a little money out of your principal savings each year. Each time you do that, the interest income for the next year will decrease, but with the right timing, your money will last longer than you do. It’s a sad thought, but that’s the reality of retirement planning.

Mr. & Mrs. Tran

The Trans estimate they’ll receive $40,800 in income and spend $48,000 each year in retirement. That’s a shortage of $7,200 annually. They could trim their budget by $600 per month and do fine, but they have grandkids to spoil and vacations to take. They don’t want to do that.

They could choose to take $7,200 annually out of their principal to make up the difference. Using one of many free online calculators for this complex formula, they see that they could keep making withdrawals for 168 months (14 years). They plan to live longer than that, so they decided against that option.

Instead, they opt to put off retirement until their daughter leaves college and they sell their house six years from now. We mentioned earlier that they save $1,500 per month toward retirement, or $18,000 per year. Six years from now, their savings would be:

  • $200,000 to start
  • $108,000 additional income saved
  • $55,400 in interest at 6%

That’s a total of $363,400 in savings when they retire. At 6% returns, that would generate $21,804 in interest each year. Add that to their $36,000 in passive income for a total of $57,804. After taxes (at 15%) that leaves just over $49,000 per year. Once they write that final mortgage payment check, they can retire comfortably with $1,000 per year left over to go overboard with gifts for their grandchildren during the holidays.Little girl and grandmother decorate a tree with ornaments

However…

One final aspect of this stage is to account for the rising cost of living. The cost of basic living expenses rises at an average of 3% per year. That means the Trans’ $48,000 of living expenses will likely be $49,440 in the following year. In 10 years, it will be closer to $65,000. Here are some actions the Trans might consider:

  • Putting off retirement further to account for this, maybe adding their monthly mortgage payment to retirement savings for several years
  • Reducing their spending, so they can pull out less than the interest earns monthly, thus increasing the interest generated each month by their savings
  • Selling their vacation home and converting that $1,000 in rent to an amount of interest

The Trans will have to do something or face real problems as they reach their 80s and 90s. This is why living on a fixed income can be such a dire situation, so account for it early as you plan your retirement.

The Variables

The above steps give you a strong formula for estimating how long your money can last, but you can take control of it by managing each of the variables in the equation.

How Much Money You’ve Saved

This variable is simple: The more you have in retirement, the longer you can live off those funds. The trick is finding ways to save extra money while living your life at an acceptable standard. A few good ideas include:

  • Maximizing all retirement contributions available from work, especially any with fund-match options
  • Pulling additional retirement savings out of your deposits the same day you get paid, so you’re not tempted to spend it on other things
  • Aggressively paying off debt, then putting the money you were paying toward debt directly into retirement savings
  • Setting a 50/50 policy on any additional earnings (raises, end-of-year bonuses, tax returns, etc.) with half going toward retirement and half to spend as you like
  • Increasing your income through a side hustle, negotiating a raise, or starting a business
  • Setting up a passive income source via investments or online

Most people discover once they set a retirement goal, finding ways to earn the extra money becomes easier than they imagined. As a bonus, some of those passive income streams can become reliable additional income once you retire.

Average Expected Return

You will want to talk with your financial advisor about this, balancing the risks of higher-value stocks against low-interest but safer options. The details of how to do this right are beyond this article’s scope, but it’s best to guess low here.

One approach is William Bengen’s 4% rule, which can be a safe baseline rate. If you make your calculations using this, you’re unlikely to have an unpleasant surprise when it comes to your interest earnings.

Reliable Additional Income

Two important details here will impact the reality of how long your retirement savings will last. First, you have to define the word “reliable.” Pensions are supposed to last for the rest of your life, but what if the provider goes bankrupt? Social Security has been at risk for decades and could very well fail or reduce payments in the decades after you retire.

You should view other forms of post-retirement income with even more skepticism. It’s possible your dividends from that little patent will keep paying $1,000 each month, but it’s more likely they’ll drop over time even as the cost of living increases. If you have rental homes, how long can you count on them turning a profit?

We’re not saying you can’t plan on these income streams during retirement. We are saying you should consider how long they will remain reliable.

Average Expected Expenses

Your retirement lifestyle is likely to be less expensive than your working lifestyle, but you don’t want to condemn yourself to golden years of austerity and financial worry. Set your goals so you can live comfortably after retirement.

One excellent technique for this is to attach your retirement date to a major financial milestone in your life. Paying off your mortgage, ending your student debt, or the graduation of your youngest child from college are all times when your out-of-pocket spending can drop considerably. The same goes for any major downsizing you might do as your life simplifies.

If you retire before the qualifying age for Medicare, you will also want to figure in health insurance costs for your living expenses. This can be substantial and make the difference between a financially successful retirement and significant fiscal stress.

Final Thought: Starting Somewhere

One all-too-common mistake potential retirees make is looking at the complexities we just discussed, then deciding not to plan for retirement. Instead, they just set a retirement date and then figure out how they can live on a combination of savings and Social Security.

A better approach is to start with an arbitrary number. This might be a retirement age, a set balance in your savings, or some other benchmark. Run the numbers for your retirement based on that starting point and see what comes out of the equation. If you like the result, you’re done (or close to it). If you don’t, make changes until you arrive at a plan you can live with for the rest of your life.

Take charge of your retirement with one of Ally Invest’s IRA options.

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Hugh Rivers, Money Crashers

Hugh Rivers was a financial advisor for 20 years. He’s now semi-retired and writes pieces about consumer finance and retirement savings.