6. HOW MUCH MONEY CAN YOU SPEND AFTER RETIREMENT?
6. HOW MUCH MONEY CAN YOU SPEND AFTER early RETIREMENT?
The 4 percent or 3 percent rule: Your view of life determines how much you need to withdraw to live a quality life after retirement without having to work a single day again. Ever!
The 4 Percent Rule
In 1994, financial planner William Bengen came up with the four percent (4%) rule. According to William Bengen's four percent rule, a retiree with a portfolio of 50 percent stocks and 50 percent bonds generating annual return of 7 percent will not outlive the funds if he or she withdraws 4 percent of the account balance the first year of retirement; and then adjusts the withdrawal amount for inflation in each year thereafter. The rule assumes the portfolio would have to last for at least 30 years.
William Bengen wrote in his 1994 study, Determining Withdrawal Rates Using Historical Data, "Assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal of 4 percent, followed by inflation-adjusted withdrawals in subsequent years, should be safe.”
It was later further confirmed and popularized by the Trinity Study (1998) based on the same data and similar analysis. According to the Trinity Study by Trinity University in 1998, "The 4 Percent Rule is a safe withdrawal rate that provides probability where one can withdraw from a retirement portfolio every year without ever running out of money. Ever."
The Four Percent Rule (with 7% annual return and 3% inflation):
The 4 Percent Rule |
Save Withdrawal Amount = Money in Investment Portfolio x 4% |
In fact, the Four Percent (4%) Rule is the inverse of the Multiply by 25 (25x) Rule. But please don't get confused the 4 Percent Rule with Multiply by 25 Rule.
Multiply by 25 Rule tells you how much money you really need to to be in your investment portfolio for retirement.
The Four Percent Rule guides you on how much money you can withdraw annually once you have retired based on how much money you have for your retirement, without cutting into your investment principle. That means you leave your investment principal or portfolio untouched.
Essentially, this rule of thumb says you can safely withdraw 4 percent of your retirement investment portfolio the first year, and then continue to safely withdraw inflation-adjusted withdrawals in subsequent years.
In this case, we can assume the future inflation rate of 3%. Therefore, for every year after your first year of retirement, you can safely withdraw an additional 3% over and above your prior year's withdrawal amount.
Let's assume that you fall into the middle class (middle 40%) income group according to Malaysia’ income classification in Report of Household Income and Basic Amenities Survey 2016. You will need RM6,502 a month (RM78,024 a year) as your hope-for living expenses after retirement.
Based on Multiply by 25 Rule, your retirement magic number will be RM1,950,600. Using the Four Percent (4%) Rule, below will be your safe withdrawal amounts during the first five years of your retirement:
Retirement Year | Annual Withdrawal Amount (4% Rule) |
Retirement Year #1 | Safe Withdrawal: RM78,024 RM1,950,600 x 4% = RM78,024 |
Retirement Year #2 | Inflation-adjusted safe withdrawal: RM80,365 RM78,024 + [RM78,024 x 3% inflation] = RM78,024 + RM2,340 = RM80,365 |
Retirement Year #3 | Inflation-adjusted safe withdrawal: RM82,776 RM80,365 + [RM80,365 x 3% inflation] = RM80,365+ RM2,411 = RM82,776 |
Retirement Year #4 | Inflation-adjusted safe withdrawal: RM85,259 RM82,776 + [RM82,776 x 3% inflation] = RM82,776 + RM2,483 = RM85,259 |
Retirement Year #5 | Inflation-adjusted safe withdrawal: RM87,715 RM85,259 + [RM85,259 x 3% inflation] = RM85,259 + RM2,558 = RM87,715 |
Again, I know there are many worriers out there due to the uncertain future. Who could predict what will happen in the next 30-40 years, right? Will you really run out of money one day? What if you run out of money 30 years later?
Well, as long as you limit your yearly withdrawals to your inflation-adjusted safe withdrawal rate as illustrated above, you can realistically expect not to run out of money and never have to work again. Ever! I hope this assurance comforts you. There is really no point to worry too much about the future. You and I can possibly live until 100 years old. But our lives can also be cut short anytime. If we do the best and the most we can today, tomorrow will take care of itself.
The 3 Percent Rule
What if you can’t generate a return of 7% annual return?
Alright, now you might say you are unable to generate a return of 7% from your investment portfolio. However, you are quite comfortable with 6% annual return using EPF's annual dividend as a guide.
If that's the case, do you think you can still retire with the same retirement magic number of RM1,950,600 as a middle income earner with hope-for living expenses of RM78,024 a year?
With the annual return being 6% now and future inflation rate still remaining at 3%, that leaves only 3% left to withdraw for spending instead of 4%.
Therefore, I won't be applying the 4 Percent Rule here. Instead, I am going to use the modified version of using one percent (1%) less, which is three percent (3%) instead of four percent (4%).
The Three Percent Rule (with 6% annual return and 3% inflation):
The 3 Percent Rule |
Save Withdrawal Amount = Money in Investment Portfolio x 3% |
Let's take a look at your safe withdrawal amounts during the first five years of retirement with the application of 3 Percent Rule (instead of 4 Percent. Our objective is to justify if you still can still retire comfortably with annual return of 6%, an inflation rate of 3% and withdrawal rate of 3%.
Retirement Year | Annual Withdrawal Amount (3% Rule) |
Retirement Year #1 | Safe Withdrawal: RM1,950,600 x |
Retirement Year #2 | Inflation-adjusted safe withdrawal: RM58,518 + [RM58,518 x 3% inflation] = RM58,518 + RM1,756 = RM60,274 |
Retirement Year #3 | Inflation-adjusted safe withdrawal: RM60,274 + [RM60,274 x 3% inflation] = RM60,274 + RM1,808 = RM62,082 |
Retirement Year #4 | Inflation-adjusted safe withdrawal: RM62,082 + [RM62,082 x 3% inflation] = RM62,082 + RM1,862 = RM63,944 |
Retirement Year #5 | Inflation-adjusted safe withdrawal: RM63,944 + [RM63,944 x 3% inflation] = RM63,944 + RM1,918 = RM65,862 |
With the 3 Percent Rule as illustrated above, you can only withdraw 75% your original annual amount to spend without touching on your investment principal the first year, and each year thereafter adjusted for 3% inflation.
Can you maintain the same standard of living with 25% reduced spending every year after retirement?
The good news is, once you retire, you may discover that it might not cost you as much to live as you had originally planned. This is because once you are no longer working, you may eliminate certain expenses.
My personal examples
Let me take myself as an example.
With my daily expense tracking, I know exactly how much I have spent before and after retirement. Over the last three years of early retirement, my annual living expenses have been reduced by at least one third compared to the times I was still working fulltime.
· Since my early retirement, I no longer need to commute daily to office. This saves me on gas and car maintenance.
· I also don't need to eat out for lunch since I can now eat at home. You know how expensive it’s to eat out every day. Hence, that’s another huge saving on food.
· And if you look at my wardrobe, I don't purchase new professional attire for work anymore.
· I also don't need to chip in money to buy birthday gifts, farewell presents, or farewell meals for office colleagues.
· I can now travel during weekdays or non-peak seasons with cheaper airfare, cheaper hotel accommodations.
· I don't need to buy an expensive new car to upkeep my professional image.
· I now have time to do home improvement and maintenance myself, without having to pay external parties to do the work.
· As I grow older, I also eat more vegetables instead of meat. Vegetables definitely cost less than chicken, beef or pork.
· I also focus on minimalist living, learning and practising “less is more”.
Therefore, if I can retire with one third (33%) reduced spending without sacrificing on my standard of living, I’m quite certain that you can also live with 25% reduced spending without sacrificing on your standard of living.
Retirement planning study in U.S. with decreasing spending after retirement
You are still not convinced?
According to a retirement planning study conducted by J.P. Morgan Asset Management analyzing the spending patterns of more than 5 million American households to evaluate real-world retirement behaviors, here are the results:
· 38% of retirees decreased their spending versus before retirement.
· 35% of retirees increased spending
· 22% didn’t change their spending habits
· 7% were roller-coasters – both increasing and decreasing their spending temporarily in retirement.
This retirement planning study of 5 million American households shows that almost four (4) in every ten (10) retirees actually decreased their spending versus before retirement.
This further proves that it’s indeed still possible for you to retire comfortably with an annual return of 6% (instead of 7%), an inflation rate of 3% and withdrawal rate of 3% (instead of 4%).
One piece of advice: If you have any large-sum outstanding housing loan, it's advisable that you fully settle all of your outstanding loans before your retirement or within the first five years of your retirement. It gives you peace of mind with zero debt, and it won't offset your retirement planning unexpectedly.
Can you withdraw more than 4%?
You may then ask, "It’s good to know that I can still retire at 75% of annual withdrawal amount based on 3 Percent Rule. Can I then withdraw more than 4 percent on first year and adjust my withdrawal amount for inflation thereafter?"
The answer is definitely a yes.
In fact, the more optimistic and carefree you are about life, the more you can withdraw. Whether it's 4.5 percent, 5 percent, 6 percent or even 7 percent, it's entirely up to you.
Afterall, chances are high that you still have other sources of income like property rentals, insurance benefits, etc.
At the worse situation, you still have your investment principal money untouched. In any emergency cases, you can then touch on your reserve if required. What you need at the end of the day is just a roof over your head. The rest can be converted into living expenses.
Unexpected extra active income after early retirement
Essentially, many people who have achieved financial independence and retire early will still find some work to do. The difference is that they no longer have to go to office to work for a boss on a job they might not like. They can choose to pursue their interests and do whatever makes them happy whenever they want.
For instance, I enjoy writing and photography. Even though it's not happening yet, but perhaps one day my interests might lead to some little spare change in my pocket. I enjoy sharing my past working experience. Hence, I become a part-time freelance consultant to my previous employer - Jobstreet.com. I enjoy developing young people, seeing them grow. Recently, I've become a part-time tutor sharing my past experiences on what courses to study in universities and how to be admitted to top US universities. These opportunities help to pay for my travel expenses after retirement.
Some people write blogs about photography, upload their cooking and recipe videos on YouTube, share their travel experiences on Facebook, and post their fitness tips on Instagram. They have a huge number of followers. And they make quite a handsome money out of their interests through product sponsorships, Google Ads advertisements, etc.
There are also many success stories of retirees who make a second career out of their passions, making more money than their past career before retirement.
All of these "extra money" generated from your passions and second career will definitely help you pay for a portion, if not all, of your living expenses after retirement. In short, it allows you to withdraw 4.5%, 5%, 6% or even 7% from your investment portfolio should you wish to do so.
Spend more and enjoy more after early retirement. After all, life is unpredictable!
Therefore, instead of worrying about “not having enough” or “spending only the minimal”, I strongly encourage you to focus on wanting to spend more and enjoy more while you are still alive and healthy.
Life is so unpredictable and fragile. Even though Malaysia's average life expectancy is getting longer and we may live until 100 years old, our lives can also be abruptly cut short anytime due to accidents, unforeseen circumstances, etc.
I have shared earlier that an ex-colleague of mine had a full-blown stroke and passed away at the age of 49. A runner friend was unfortunately hit by a car in a running event and she passed away at the age of 46. Thus, we might as well live life to the fullest while alive.
Meanwhile, you shouldn’t overly analyse 25x or 33 Rule and 4% or 3% Rule to the exact amount until it cripples your retirement plan and deprive you from living a quality life after retirement.
Sometimes it's better to just go with the flow rather than try to plan everything out exactly to the dot. You need to live every day to the fullest while you can still breathe. More so after your retirement as time is running out. That's how I perceive life now. I'm grateful for every moment I'm alive.
So should you.
This chapter also concludes the first section on financial independence.
In the next section, I will share on investing in your yourself and your career.
SECTION 1
ABOUT FINANCIAL INDEPENDENCE
“When we allow our finances to control us, we give up many freedoms we value. The only way to gain those freedoms back is by taking control of our money.”
Darron Rowley
F I L L
Financial Independence, Live Life
achieving financial independence from 9-to-5 job before 50
Book manuscript written in 2020 & blog articles published in 2021 by Vincent Khor
