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One of the hardest questions for people approaching retirement is to figure out how much annual income their retirement savings can generate. That’s the $64,000 question for retirees because they equate income to the living standard they are accustomed to. A careful answer should consider the overall financial picture, retirement horizon, retirement goals, preferences, and each household’s ability to adjust to setbacks.
To keep things simple, we use historical data to define a reasonable range as a starting point, and then point to considerations to help refine what may work for you. The approach should at least help you get started with your retirement plan and help you understand the nature of the question.
Portfolio Returns and Sustainable Income Here in Austin Texas
Research shows that a moderate allocation to stocks can help your portfolio sustain higher withdrawals over long periods of time. However, the uncertainty that comes with stock returns translates into uncertainty about how much income the portfolio can generate. One way to measure this uncertainty is to look at historical returns over long periods, say 30 years, and estimate how much income a portfolio could have generated across different 30-year periods.
For example, if you retired in January 1990 with $1 million, what is the maximum income that a portfolio could sustain over the 30 years between 1990 and 2019? With the benefit of hindsight about returns, and assuming the portfolio is completely exhausted at the end of the 30 year period, a $1 million in January 1990 could have sustained $64,000 annually. The calculation assumes that the $64,000 would be adjusted upward for inflation every year.
In 1990, we could not know that we could sustain $64,000 annually because we could not know the returns over the next 30 years. But the calculation is useful because we can repeat this process for every year for which we have marked data, starting in 1871. By doing this for every year between 1871 and 1991 (the latest 30 year period available), we can generate a range of sustainable income levels across a variety of possible return scenarios.
The following table shows the sustainable rate for the 30 year periods starting in 1990 and in 1974. For the period starting in 1974, the returns were such that about $52,000 adjusted for inflation every year was sustainable. We only reproduce the first 5 years for convenience. Every year, we take the income from the previous year and we increase by the inflation rate experienced in the year. We start with $52K in 1974, then increase it to $58K in 1975, $62K in 1976, and so on every year to maintain purchasing power. At the end of the 30 year the portfolio is completely exhausted.
| Start Year | Variable | Y1 | Y2 | Y3 | Y4 | Y5 |
| 1974 | Inflation | 12.3% | 6.9% | 4.9% | 6.7% | |
| Income | $52,000 | $58,416 | $62,468 | $65,506 | $69,896 | |
| 1990 | Inflation | 6.1% | 3.1% | 2.9% | 2.7% | |
| Income | $64,000 | $67,908 | $69,989 | $72,019 | $73,998 |
Why the difference between the two years? It turns out that the annualized returns (adjusted for inflation) over the two thirty-year periods, assuming a 60/40 portfolio, were very similar (5.3% for the 1974 start vs 4.9% for the 1990 start). However, the sequence of the two returns was different. The 1974 period had much lower real returns (about 2%) over the first 10 years than the 1990 period (about 10% per year). It turns out that the returns over the first 5 to 10 years matter more than the average return over the entire 30 year period, a point we developed in another post.
Sustainable Income
What we did for 1974 and 1990 can be repeated for all the 30-year periods for which we have data (there are 121 such periods). The next figure illustrates just that. Each blue bar represents the maximum sustainable income for each of the years in the sample. The range goes from $40,000 (1966 start year) to $99,000 (1877 start year). The median across the 30-year periods is $63,000, similar to the 1990 period, and 75% of the time, income is approximately $50,000 or greater. This explains why we illustrated the 1974 and 1990 periods.
Maximum Sustainable Income ($ thousands; 30-year horizons)
The plot shows the maximum sustainable income from $1 million over 30 years. Source: DESMO Wealth Advisors, LLC calculations using a line-search algorithm. Historical data from Rober Shiller from 1871 to 1925, and Ibbotson data from Dimensional Fund Advisors, since 1926.
What can we learn from the historical distribution of sustainable income? To answer, keep in mind that in the last 150 years on which we base the analysis, we experienced two world wars, a number of banking and financial panics, the Great Depression, the Great Inflation period, monetary policy mistakes, and low and high interest rates. Thus, the historical data is rich in potential scenarios for portfolio returns. Historically, the lowest sustainable income, $40,000, is 4% of the initial $1 million. The same calculation gives rise to the so-called “4% rule”: start with 4% of your initial portfolio value, and every year adjust for inflation. You can see where the rule comes from. It picks the most conservative of the potential outcomes.
The result of using the most conservative outcome is that if returns are similar to any other 30-year period in the sample, you expect to end the 30 years with an unspent sum of money. That may be good for your heir but it also means you could have had a better lifestyle in retirement.
Choosing Your Income Level
One way to think about the different levels is in terms of the likelihood you would have to adjust your spending down the road. Historically, you never had to adjust your withdrawals downward if you took $40,000 a year. At $45,000 a year, you would have to adjust downward in fewer than 10% of the 30-year periods. At $50,000, about 25% of the periods. At the median level of $63,000, 50% of the periods.
Which level in the $40,000 to $63,000 range to choose depends on individual circumstances, your preferences for risk, and the flexibility to adjust your spending if returns over time are less than expected.
Individual Factors to Consider and Talking to a Fee-Only Fiduciary in Austin
The first factor to consider is the retirement horizon. We considered here a 30-year horizon, which is typical for people retiring around age 62-65. For a longer horizon, sustainable incomes will be lower (for longer horizons, check out this post).
That said, suppose 30 year is a valid horizon, a reasonable starting level of income can be a bit higher than $40,000. In 90% of the cases, sustainable income is greater than $45,000 annually, so that could be a reasonable starting point. If you have the flexibility to adjust your portfolio income downward down the road, at least temporarily, starting with a higher level may be acceptable.
Some ways to reduce your portfolio income needs are reducing or postponing spending, reallocating resources from other goals, generating part-time income, and collecting Social Security benefits a bit earlier than planned. How much more than the more conservative $45-$50K depends on your flexibility and capacity to adjust if returns over the first 5-10 years in retirement are lower than expected.
Your risk preferences matter too. The biggest fear among retirees is to run out of money. If you can rely on Social Security for at least your basic needs and you can handle some market fluctuations without panicking, then you can take more risk by increasing the withdrawal amount, which in any event should be less than the median value of about $64K. Additional considerations about withdrawal strategies can be found here.
For many people, the retirement portfolio includes taxable accounts, tax-deferred accounts like a 401(k), IRAs or similar, and tax-exempt accounts like Roth IRAs. A tax-efficient withdrawal strategy that considers the interaction of these different sources of income in addition to Social Security can help increase the level of sustainable income.
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Identifying a sustainable income level from your retirement portfolio is the $64,000 question of retirement planning. Historical evidence and a few individual considerations can get you started in the right direction, help you understand the uncertainty around income estimates, and as a sanity check against recommendations. For peace of mind, work with a trusted advisor to create a retirement plan.
Massi De Santis is an Austin, TX fee-only financial planner and founder of DESMO Wealth Advisors, LLC. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow, and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.
