1

If you have a fixed income that was going to continue for the rest of your life, what portion would you need to save to keep it consistent?

For example, if you were to get 100,000 per year non indexed, how much would you need to save so that the total amount you lived on did not degrade? If the inflation rate is 2%, then next year the amount is not as valuable to you, but if you spent less and saved some, how much would you need to save? I would be happy to see some formulas.

A few assumptions:

  • No draw down is included; it should last forever.
  • Interest rates and inflation rates can vary.
  • What age are you starting, what's your life expectancy, and is the goal to have zero savings in the life expectancy year? – user662852 May 5 '16 at 12:27
  • Assume living indefinitely or if an age is require, say 35 until 80 – user1605665 May 5 '16 at 22:44
4

The usual rule of thumb is that you can pretty safely expect 4% passive return on a reasonably safe mix of investments. (Historical average of "market rate of return" has been closed to 8%, so this is a reasonably conservative number. It also provides some buffer against inflation.)

So: Figure out what your yearly needs will be -- remember to average in emergencies and allow for tax -- then divide by 0.04 (multiply by 25), and you've got reasonable odds of being able to live entirely on the income without ever drawing down the principal... Which again gives you some buffer space.

If you are willing to burn down the savings over some estimated lifetime, the target number is reduced but the math gets more complicated -- it's similar to calculating a loan, backward.

(If you don't want to do the math yourself, try asking an insurance company what it would cost to buy an annuity which pays that much per year; they're basically running that calculation based on their best guess of your life expectancy and acting some for their processing costs and profit.)

  • I believe the OP starts with zero savings and a fixed 100k cash stream per year - I couldn't press the 4% withdrawal rule of thumb into this setup. – user662852 May 5 '16 at 12:32
  • The 4% gives them a target. They still have to determine how to save enough to reach that target (sided by compound returns). That's the inside-out loan problem again if you want a fixed number, though there's more bang for the buck at the start of the process. – keshlam May 5 '16 at 14:11
  • As this is ongoing, instead of using a fixed 4% (or whatever) you can update monthly or annually with whatever the actual rate of inflation happened to be. – jamesqf May 5 '16 at 17:38
  • The 4% "safe withdrawal rate" was for a 30 year period. For a 45-to-infinite year period you need to use a lower withdrawal rate. – stannius May 6 '16 at 19:49
  • @stannius: According to my model, assuming market rate of return doesn't drop and 3% inflation and no completely catastrophic medical expenses, 4% does indeed last close enough to forever. Quicken's model agrees. I haven't asked my advisor specifically, but all three models come up with essentially the same target savings so I'm presuming similar projections. In fact I hope to be well over that 25x value before being forced to retire, but that's still the number I use for an "at least" figure. Your milage will vary. Void where prohibited. – keshlam May 6 '16 at 20:37

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