May 1, 2024
How much money should you withdraw from your retirement savings each year? When should you claim Social Security? How much will healthcare cost? There are many questions on the minds of soon-to-be retirees.
But there’s one common retirement trap that is rarely talked about.
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In one of his YouTube videos, former financial advisor Humphrey Yang said that the biggest trap is “going into retirement without knowing how much [money] is enough and constantly wanting more.”
Yang explained that the problem is more psychological than financial. “Everybody always wants more money, especially in the society that we live in — and I think that drives a harmful type of mindset,” he said.
Here’s how to replace financial uncertainty with greater clarity as you head into your golden years.
Why is this retirement trap so common?
There are no hard-and-fast rules that govern how much money you need in order to retire because personal situations can vary — but that can result in high levels of uncertainty for those about to retire.
It still hasn’t stopped many soon-to-be retirees from seeking financial certainty in the form of some sort of concrete monetary milestone. For example, having $1 million in savings and investments was once considered a “magic number” for retirement for years.
The problem is that the magic figure is now closer to $1.46 million and, as the Wall Street Journal noted when reporting on that revised number, “there is no single formula for how much you need to save in your 401(k).”
Meanwhile, trying to calculate what you might spend during retirement is a direct result of how you plan to spend your time — however, those goals (like travel) don’t always pan out.
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Yang cited statistics from the U.S. Department of Labor, which shows that, as of 2017, Americans aged 65 and older spent two-thirds of their day sleeping and participating in sports and leisure activities — which includes, on average, 4.5 hours of TV a day. As for socializing, the average retiree only spent roughly 30 minutes per day on this.
So, how does one figure out their magic number for their retirement years?
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Using the 4% rule
How much of your nest egg can you spend each year without running out of funds in retirement? That’s where the 4% rule might come into play. In essence, it’s the idea that you need to have enough money set aside so you can live on 4% withdrawals annually.
Yang’s take on the 4% rule involves tapping into that amount from your retirement account yearly. (Other experts suggest increasing or decreasing those withdrawals based on inflation rate.)
Assuming a 50/50 split of stocks and bonds allocation in a portfolio is worth $1 million, Yang said you should be able to take out $40,000 per year for 25 years and never run out of money in 97% of back-tested scenarios.
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Keep in mind, though, that a 4% withdrawal rate in Oklahoma (which had the lowest overall cost of living in 2023) will go twice as far as Hawaii — the most expensive state. Before retiring, be sure to gauge whether 4% is truly enough for your location.
Even financial advisor William Bengen — the creator of the 4% rule — now recommends making it the 5% rule based on the current level of inflation.
Knowing exactly how much you spend
Another strategy Yang suggested is to keep tabs on your spending habits. Ideally, this would be done prior to retirement on a monthly or annual basis. This would allow soon-to-be retirees the opportunity to reflect on how much money they might actually need in retirement.
“If you’re only spending about $30,000 per year in expenses, then you know that your portfolio size needs to be $750,000,” Yang offered as an example. “That allows you to withdraw 4% from it every year in perpetuity.”
On average, Yang said, retirees tend to spend less money on clothing, housing and food, which will help lower some costs once they’ve left the workforce. However, if you’re still worried that your savings won’t be enough to sustain you, there’s always the opportunity to build passive income streams to supplement your retirement.
According to Fidelity’s 2024 State of Retirement Planning survey, 57% of Americans said their retirement will include working — at least part-time.
Not sure where to start? Some of the best side hustles for seniors that allow for plenty of flexibility and possible social connections include freelance writing (or editing), dog walking, being a tour guide at a local museum or art gallery or selling handcrafted items on Etsy.
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Lou Carlozo is a freelance contributor to Moneywise.
