Surveys consistently show that running out of money in retirement is one of the biggest financial fears. Perhaps that is the reason we find a lot of our retired clients are reluctant to spend money, even if it is for something they really want or a vacation they have dreamed of for many years. The thought that “I may need this money in the future if something happens” prevents them from doing the things they envisioned when planning for retirement in the first place.
We have two ways of approaching this issue when clients ask whether they can afford to spend a certain amount of money beyond their budget. The first is the 4% prudent withdrawal rule. I’ve covered this topic in a recent blog, so I won’t go into a lot of detail here. Basically if the amount of spending is going to be less than 4% of their account value, their accounts should be able to support the withdrawal.
The second way we approach this issue is to look back at the trailing 12 months. We want our client’s accounts to grow each year by the rate of inflation after withdrawals. Account growth above that amount would be considered excess earnings for the period and could prudently be spent. For example, someone with a $1 million nest egg that is withdrawing 4% would withdraw $40,000 in a 12-month period of time. If their accounts grew by 10% and inflation was at 3%, they would have excess earnings of 3% or $30,000. This would be a good time to buy that new car of take the vacation that they have been putting off. I find that many people are more comfortable with this approach because the money has already been earned.
A successful retirement is as much about controlling spending as it is about investment results. Keep your projected spending at 4% or less of the account value and use the excess earnings look back rule to keep your spending within prudent guidelines.