A reader writes in to ask,
“Does it make sense to apply what I call the ‘retirement model’ to a large windfall — that is, spending a percentage of the windfall each year, while allowing the rest to grow? If so, what withdrawal rate do you recommend? The 4% rule, I gather, means that the money could likely run out after 30 years or so. Since I am 33 now, that means that it could run out just as I was hitting retirement. What withdrawal rate should I use to have the money last until I am 100?
And what about your readers? I’d be curious to see how other readers have dealt with this experience.”
Mike’s note: What follows is my answer to this question. If you’re comfortable sharing your own answer, please chime in via the comments section on this post.
You’re right that if you wanted the money to last for 60+ years, it would be wise to use a withdrawal rate lower than 4%.
To back up a step though, I doubt that’s the approach I’d apply at all. Rather than thinking about at what rate you can spend from this money, I’d simply incorporate the windfall into your existing plans. That is, now that you have this additional money, at what rate (if any) do you still need to be saving for retirement and other financial goals?
Matching Resources to Goals
To go about answering this question, I’d make a list of your financial goals in order of importance. For example:
- Basic retirement living expenses,
- A replacement for your aging car,
- College for children,
- “Fun” spending in retirement,
Then I’d make a list of resources available to meet those goals:
- Your current and future work income,
- Your existing savings (including the new windfall),
- Social Security,
Then I’d play a matching game — allocating resources to satisfy your goals in order of importance. Once the highest priority goal is satisfied (using any combination of resources), you can start allocating resources to the next highest priority.
For example, if retirement is the #1 priority, are your existing savings (including the windfall) large enough that they would likely fund your retirement if you let them grow untouched between now and your planned retirement age? If so, then you no longer need to save for retirement every year, and you can begin allocating resources to other goals. (Of course, this decision should be revisited periodically based on how well the money is/isn’t growing over time.)
Tax-planning note: Even if you no longer have to save for retirement per se, it still likely makes sense to max out your retirement accounts every year. For example, contribute $16,500 to a 401(k) and $5,000 to a Roth IRA, while spending $21,500 out of the taxable windfall you received in order to effectively transfer as much of the windfall as possible to tax-advantaged accounts.
In short, my suggestion would be to make decisions from the broader perspective of how to meet as many of your goals as possible (in order of importance) using your total resources rather than trying to figure out what to do with just this one part of your resources.