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Every article I read nowadays talks about building your nest egg up to a point where you can live on a yearly income of 4% of that nest egg. If you get your nest egg to that point, why does it matter what age you work until? For example, if I can live on $80,000/year (pre-tax) and I build up a nest egg of $2 million, can't I count on living on my gains without ever touching my principal? I mean on average, I should be able to make at least 4%/year on my money. So, if this is true, and I can live only on my gains/interest income, why does it matter whether I retire at 50, 60 or 68? Any thoughts?
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Every article I read nowadays talks about building your nest egg up to a point where you can live on a yearly income of 4% of that nest egg. If you get your nest egg to that point, why does it matter what age you work until? For example, if I can live on $80,000/year (pre-tax) and I build up a nest egg of $2 million, can't I count on living on my gains without ever touching my principal? I mean on average, I should be able to make at least 4%/year on my money. So, if this is true, and I can live only on my gains/interest income, why does it matter whether I retire at 50, 60 or 68? Any thoughts?

The underlying assumptions of the 4% withdrawl rate are that your initial withdrawl is 4% and adjusts upward for inflation each year thereafter - in otherwords, you withdraw an equal amount of purchasing power each year. Another assumption is that this is for a 30 year time frame. Other timeframes have different safe withdrawl rates - longer times would have a lower withdrawl rate. Also, this does not mean that you will not touch your principal - when the market is down, you will definately be drawing down principal. This strategy is predicated on having a very high probability of not running out of money. There is nothing to say that you won't only have $1 left. The amount you have left will depend on the actual sequence of returns you realize every year.

Your strategy of not touching the principal does not take in to account increasing your withdrawls to account for inflation.

foolazis
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For example, if I can live on $80,000/year (pre-tax) and I build up a nest egg of $2 million, can't I count on living on my gains without ever touching my principal? I mean on average, I should be able to make at least 4%/year on my money. So, if this is true, and I can live only on my gains/interest income, why does it matter whether I retire at 50, 60 or 68? Any thoughts?

First of all, because of inflation, your living expenses won't stay at $80k a year. So you would soon need to be taking out more than your 4% 'average' return.

Then, the problem is, what if the year isn't average? What if you retire and for the next 3 years, and your portfolio returns are -4%, -10% and -2% because 2 year long bear market started 6 months after you retired? If you 'live only on your gains/interest income', where are you going to get the $80k, $200k and $40k to add to your portfolio to keep it at $2 million, much less the additional $80k to live on?

Your plan needs to account for the probability that you will draw down your principal during at least some years, which is why the longer you think your retirement will be, the lower the 'safe' withdrawal rate will be. For historical 30 year periods, it has been shown that by starting with a 4% withdrawal in year 1 and increasing the withdrawal with the rate of inflation, you will not run out of money for those 30 years. You may have had $1 left at the end of some 30 year periods, and at the end of others, you may have $2 million (or more) left.

Unfortunately, predicting what the markets will do for the next 30 - 45 years is impossible, so it is better to err on the side of conservatism if you don't want to run out of money at age 85, after retiring at 50.

AJ
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The problem is that if you have back luck an retire just before a string of bad years, then when the theoretical good years come to offset these, you portfolio had been so reduced that it will never recover.

For example the S&P 500 now is just about where it was at it its prior peak in 2000, In inflation adjusted dollars it will still probably have a gain another 15% or so just to be the same after inflation. Anyone who retied then, or a few years before, could have already drawn down their portfolio by a third in inflation-adjusted dollars because of the overall returns. For the portfolio to recover, it would have had to gain 50% of what is now left while still making the 4% withdrawals.

This doesn't just happen after market bubbles, there have been lots of times when the market has taken many years to reach the prior highs.

Greg
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A major wild card in the equation is health care. You need to make adequate provision for that. Even then, unexpected things may happen. I got an infection after a back operation and had to have 8 weeks of IV antibiotics. Insurance would not pay for the home nursing or even for all of the cost of the antibiotics. That cost me about $6000 extra.

So far as retiring just before a string of bad years, you are supposed to have sense enough to sell and not just hold long through a bear market. I did not make much of anything between March 2000 and March 2003, since I was in interest-paying stuff for the most part. Still, I emerged from that bad period pretty much intact.

Much of what passes for retirement advice assumes that you are going to be investment-comatose during the period, or maybe just senile. Hopefully not.
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On top of what has already been said, some of your tax deferred accounts might have certain restrictions on how much you can (or have to take out) before certain ages. And sometimes you are locked into that withdrawal rate.

Inflation is a personal thing. If cost of housing, new cars, college tuition is going up and adding to "inflation", but you don't have those expenses, then it doesn't matter. However, if bass fishing lures go up 1000% in 5 years, it might put a crimp in your retirement lifestyle.

JLC
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Every article I read nowadays talks about building your nest egg up to a point where you can live on a yearly income of 4% of that nest egg. If you get your nest egg to that point, why does it matter what age you work until? For example, if I can live on $80,000/year (pre-tax) and I build up a nest egg of $2 million, can't I count on living on my gains without ever touching my principal? I mean on average, I should be able to make at least 4%/year on my money. So, if this is true, and I can live only on my gains/interest income, why does it matter whether I retire at 50, 60 or 68? Any thoughts?

You have it exactly right. I'll be doing that very thing sometime in the next 6-8 months, well before I turn 50.

joe
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"If you get your nest egg to that point, why does it matter what age you work until? For example, if I can live on $80,000/year (pre-tax) and I build up a nest egg of $2 million, can't I count on living on my gains without ever touching my principal? "

That is two questions.

1) It does matter what age you retire at. The 4% 'rule of thumb' first assumes you have a balanced well allocated portfolio. That is for a 30 years withdrawal period.

If you have a longer time horizon, the withdrawal rate will be lower. For 40 years, less. For 50 years, even less.

2) The 4% SWR assumes that you may eat up your entire principle in those 30 years, 'worst case' - that being the worst case for any 30 year period in history. You could wind up broke on the last day of the 30th year. That doesn't happen often, but in some of the periods in the past, you would have definitely eaten into your 'nest egg'. So no, you cannot count on living forever and not having to touch your nest egg.





"I mean on average, I should be able to make at least 4%/year on my money. So, if this is true, and I can live only on my gains/interest income, why does it matter whether I retire at 50, 60 or 68? Any thoughts?"

You first need to make 4% above and beyond inflation, real gain. That doesn't always happen. You have been now in the best 30 year investing cycle in most people's lives. It isn't always this good. Historically it can be horrible, with annual losses each year of 1.5% or 5% or 15%. You could have five years in a row like that.

For periods longer than 30 years, the SWR goes down.

t.
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Upnup8,

You might find this article interesting on the probabilities that underlie that 4% draw concept:

http://www.afcpe.org/doc/Vol1014.pdf

Ken
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Every article I read nowadays talks about building your nest egg up to a point where you can live on a yearly income of 4% of that nest egg. If you get your nest egg to that point, why does it matter what age you work until? For example, if I can live on $80,000/year (pre-tax) and I build up a nest egg of $2 million, can't I count on living on my gains without ever touching my principal? I mean on average, I should be able to make at least 4%/year on my money. So, if this is true, and I can live only on my gains/interest income, why does it matter whether I retire at 50, 60 or 68? Any thoughts?


Well, in the first place, if you're withdrawing from a tax deferred account before the age of 59 1/2, the IRS will restrict you on how much you can withdraw.

https://web.fidelity.com/seqp/application/SEQPIntro

http://www.brentmark.com/periodic.htm

http://www.irs.gov/retirement/article/0,,id=103045,00.html

Try this web page to calculate what you can withdraw. There are two calculation methods and the results are shown side by side. You only need enter one set of data. https://web.fidelity.com/seqp/application/SEQPCalculator

What other people said about allowing for inflation and some bad market years also apply. My 401k took quite a beating between 2000 and 2002.

I retired in 2001 at 55. I'll be 61 in August. Until this year, my wife and I lived on proceeds from taxable accounts (which we still have, albeit somewhat diminished from their original state).

My own rule of thumb is to use a 3.33333% rule for withdrawals. This was based on the rather simplistic method of assuming I will live to 90 (highly probable given family longevity), and then assuming that this rate of withdrawal would exhaust my funds just about the time I shuffle off this mortal coil. It gives a withdrawal rate quite a bit under what is considered "safe" for a 30 year time period. This also assumed that I would not claim Social Security (see), but would have the benefit of my wife's teachers pension. It's a small one and I won't go into details why it is as small as it is other than to say that my wife was out of teaching for approximately 20 years, her first husband insisted that she withdraw her pension when she left teaching the first time and the fact that, after discussion, we decided it wasn't worth "buying back" the missing years.

Social Security: Initially, I planned for retirement without Social Security (basically because I thought it unfair to claim it if not needed). That is, until I told my wife about that plan and she read me the riot act. I figured I'd have enough without it. After being metaphorically "hit upside the head", I realized that our kids are paying into SS and that if I don't claim it, those payments will be going to someone else. By claiming SS, even if it's not strictly necessary for financial well being, I can further reduce my rate of withdrawal and have a very good chance of leaving the kids a nice nest egg, or save the additional funds to help send grandkids (4th one born yesterday) go to college. After running various scenarios (most of which include the possibility of SS being means tested or benefits reduced), I determined that my best option was to claim SS when I turn 62 next summer.

I also plan to keep us in the 15% marginal income tax bracket. I've found, through 6 years of experience, that we can live on roughly half of our pre-retirement income. Most "gurus" start at a minimum of 60% of pre-retirement income and some even suggest that you may need 100% of pre-retirement income.

General rules we have.

1. No credit card debt, ever. We do use credit cards, but pay the balance in full every month.

2. If we can't pay cash, we can't afford it. If we really want it, we save for it (i.e. items that would not be immediately payable under rule #1).

3. No mortgage debt. If you can pay off your house early, do it. Debt service requires additional income. No debt, no need for the additional income. Pay off your mortgage early, and that amount can be saved (most of it in a taxable account) for your retirement. It never has made sense to me to pay $1.00 in interest to save 15 or 25 or whatever cents in taxes. That dollar could be earning money for you.

There's offense (i.e. actively saving/investing) AND defense in financial matters. Defense consists of minimizing expenses and living well within your means. Both matter and both will affect the ultimate bottom line.

Churchy
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Social Security (see)

additional funds to help send grandkids (4th one born yesterday) go to college


Note to self: Self, edit this stuff before posting.



That should read:

.... Social Security (see below)

.... additional funds to help send grandkids (4th one born yesterday) to college.
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