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How Long Will Your 401(k) Funds Last In Retirement?

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With pensions increasingly rare and the future of Social Security uncertain, many people rely on their 401(k) plans to provide lifetime income once they retire. The problem with this strategy is that no one knows just how long that lifetime will be.

And that’s not the only thing that’s uncertain when it comes to retirement planning.

First of all, investment returns vary. In the last 15 years, we’ve seen 5-year CD interest rates fluctuate from a high of close to 6% to a low of around 1%. During this same period, the Dow Jones Industrial average started at around 9200 in 1999, then hit a low of around 6,600 in March 2009 and danced around 17,000 in September 2014.

You also don’t know just how much income you’ll need in the future. Well, except that you can assume you will need more tomorrow than you need today. According to the Bureau of Labor Statistics, you’d have needed about $226,000 in 2013 to purchase what cost $100,000 in 1983.

So you don't know how long you will live, how much you will earn on your investments, or how much income you will need. There are a lot of variables, and the stakes are high — if you get it wrong, you may run out of money in retirement.

 Luckily, there are a few things you can do to plan for a lifetime income in an uncertain environment.

1. Use meaningful assumptions.

There are many unknowns in retirement planning, so you have to make some assumptions about longevity, interest rates, and inflation. Make sure they are tailored to your personal situation.

Longevity. According to a 2012 study by the Society of Actuaries, people tend to underestimate their longevity. 42% of men in the study underestimated the life expectancy of a 65-year-old man by five or more years, and half the women underestimated the life expectancy of a 65 year-old woman.

If you are married and healthy, your life expectancy could be longer than you think.  The American Academy of Actuaries, in their paper, Risky Business: Living Longer Without Income for Life,  cite an often reported statistic that married couples once they reach 65, a survivor has an 18% chance of living to age 95.  But when you take into account people who have a lower mortality risk (in good health, led healthy lifestyles and worked in jobs that didn’t take a physical toll,) the chance of one of the partners living to 95 jumps to 31%.  To estimate your life expectancy, check out this Living-to-100 calculator.

Rising prices. Pre-retirees who may be more vulnerable to rising inflation (such as renters) should consider using an inflation factor higher than the average 3.25%. You want to ensure your plan doesn’t fail as prices rise.

Interest rates. With interest rates at historic lows and the financial crisis of 2008 just behind us, I haven’t run into too many people who are over-optimistic about investment returns. Err on the side of conservative return assumptions.

2. Don’t “set it and forget it.”

Review your retirement plan at least annually and as your circumstances change. A raise or a job change could occur, a windfall may come your way, or you could end up with a salary reduction.

Making small adjustments annually, such as increasing your 401(k) contributions by 1% a year, may help you avoid having to make major adjustments later. It’s easier to make incremental changes than to double your contributions later on — or work longer.

 3. Translate into everyday terms.

How much do you need in a lump sum to provide lifetime income? It’s hard to get your head around, because we tend to think of income in monthly terms rather than as a lump sum.

The Department of Labor has proposed to require defined contribution pension plans to provide illustrations of what a participant's 401(k) contributions and balance translate into a lifetime monthly retirement benefit. Why wait for this to be provided by your employer?

Working with a financial planner can be enormously helpful when you’re trying to customize and personalize your retirement plan.

Also, there are a number of helpful online calculators:

Department of Labor Lifetime Income calculator and Bankrate.com – don’t include Social Security or other income, but translate your lump sum to a monthly income while taking taxes, inflation and longevity into consideration. Dinkytown and Yahoo Finance’s calculator will map out how many years your lump sum will last, taking into account taxes and inflation.

4. Remember “garbage in – garbage out.”

What information are you using to make your financial planning decisions? I recently talked with a business owner about how much he would need to sell his business for to provide a lifetime income.

He simply figured if he earned 4% a year on his lump sum, he’d be set. That might have worked for a year or two — until inflation kicked in, prices went up and his income didn’t. He also hadn’t considered taxes on the sale of his business or on the income stream. If he’d used the basic 4% rule, his needs might not have been met.

5. Employ Murphy’s Law.  

In retirement planning, applying Murphy’s Law, “Anything that can go wrong will,” to your planning is vital. Since your plan must succeed, it’s important to build in contingencies.

Calculate how your plan will look with many years of high inflation, low earnings, retiring earlier than you planned and other possibilities. Many financial planners build in a surplus of 20% or more over the lump sum you might need in retirement — just in case.

 Though retirement planning may seem like a shot in the dark, it’s really not. Planning an income stream to last a lifetime takes thoughtful planning, meaningful assumptions, and regular review.

Retirement planning may not be something you want as a DIY project, however, since it is something you don’t want to get wrong!  Consider working with a Certified Financial Planner ™ professional.