Retirement: How long will my money last?

By Walter Updegrave, senior editor


(Money Magazine) -- I have $200,000 earning 4% a year. If I start withdrawing $1,000 a month, how long will my money last? -- Linda T., Bemidji, Minnesota

Ah, the old "How long will my money last?" question. Sounds to me like someone's trying to figure out whether her savings will carry her through retirement.

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If that's the case, I think it's great that you're asking this question before you actually start pulling a thousand bucks from your account each month.

Better to have a sense ahead of time how long you might be able to count on that monthly grand rather than have it run out sooner than you expected (or last a lot longer, which means you could have afforded to spend more each month).

That said, I think you would be even better off if you also considered some other ways you might draw down your two hundred thou, since the method you're suggesting has some practical drawbacks.

To illustrate what I'm talking about, let me start by answering your question at face value. If you have $200,000 invested in an account that will allow you to withdraw $1,000 a month while still paying 4% year after year after year, your money will last 324 months, or 27 years.

Actually, your 323rd monthly withdrawal would leave you with just under $500, so you would come up short of a grand that last month. But while the withdrawal scenario you've outlined is certainly possible in theory, you would run into problems trying to pull it off with such precision in the real world.

For example, your first hurdle is finding an investment that will earn a steady 4% annually. Yes, I know you say your $200,000 is earning 4% now. But the question is can you really count on getting that return like clockwork for 27 years?

Low-risk investments like money funds and CDs can't give you that assurance. They don't pay enough or allow you to lock in the return for long enough. Stocks have the potential for paying more than 4%, but as the 2008 meltdown and recent market turmoil has demonstrated all too well, stock returns are volatile.

And even relatively more stable dividend-paying stocks go up and down with the market, not to mention the fact that their dividends can be cut.

But what about good old Treasury bonds? Recently, 20-year Treasuries yielded roughly 4.2%, while 30-year Treasuries yielded about 4.4%.

So you might figure, bingo! By investing your $200,000 in long-term Treasuries you should easily be able to earn more than 4% a year for the next 27 years and get your $1,000 a month.

But reality intrudes again. Let's say for argument's sake that you invest your entire $200,000 in Treasury bonds that will mature in 27 years. And let's assume that you get a yield of 4.3%, a bit more than 20-year Treasuries are paying and a bit less than 30-year Treasuries.

In theory, assuming a 4.3% constant return, you should be able to withdraw $1,000 a month for 342 months, or almost 30 years. Problem is, at a 4.3% yield, your $200,000 worth of bonds would throw off only $8,600 a year, or $717 a month.

So to get that other $283 to bring the draw to the $1,000 you want, you would have to sell some bonds, about $3,400 worth each year. And here's the rub: When you sell those Treasury bonds, the price you get will depend on the ups and downs of interest rates.

In some months, your bonds will fetch a lower price than in others. Which means you might have to sell more bonds in some months to raise that $3,400.

To the extent you have to unload more bonds, that will leave you with even fewer bonds in your account, making it tougher to generate the $1,000 a month in future years.

True, if interest rates fall, bond prices would rise and you could profit on the sale. But the point is that once you have to start liquidating bonds to insure your $1,000-a-month draw, you can't be sure of earning a steady 4.3% return on your $200,000 investment over 27 years.

All of which is to say that unless that $200,000 of yours is in an investment that earns 4% interest and allows you to withdraw $1,000 a month while still guaranteeing that 4% annual return without deviation for 27 years -- and I can't imagine what that investment would be -- then you can't really be sure how long your money will last.

Which brings us back to my earlier suggestion that perhaps you should think of other ways to get $1,000 a month out of your $200,000. Turns out that there is one investment that can give you an assured stream of payments. It's called an immediate annuity.

Essentially, you hand over a lump sum to an insurance company, and in return the insurer promises to pay you a specific amount every month, based on factors such as your age and the prevailing level of interest rates.

So, for example, if you go to our Income For Life calculator, you'll see that a 65-year-old woman who puts $200,000 into an immediate annuity would receive $1,180 a month for the rest of her life.

(Actually, that amount is an average of what many different insurers are paying. She might get more from some insurers, less from others. A 65-year-old man would receive a higher payment because men have a lower life expectancy than women.)

If that 65-year-old woman lives to age 92, then she'll get the $1,180 a month for 27 years. If she lives to 95, then receive payments for 30 years. And if she hits the century mark, she'll collect payments for 35 years.

In short, by taking an immediate annuity's lifetime income option, the money will keep flowing in until she dies. If she's married, she and her spouse can choose a "joint and survivor" option that will assure the income continues to roll in as long as one of them is alive (although the payment for a joint and survivor option is smaller than that for one person).

Now, just as drawing $1,000 a month from your $200,000 has pitfalls (you might run out or you might find out later that you could have spent more), so do immediate annuities.

For one thing, you give up access to your $200,000 in return for the assured income. So you can't tap into it for emergencies. If you die soon after buying the annuity, your heirs get none of that money.

The reason is that the money that would have gone to annuity owners who die earlier in life goes to those who live longer. Those "mortality credits" are why immediate annuities can generate more lifetime income for a given rate of return than you can on your own.

(There are some annuities that allow you limited access to your money or allow you to leave some to heirs. But such options lower your payments and undermine what an annuity does best, which is provide the highest possible level of assured income for life.)

You should also know that while people speak of the lifetime income that annuities provide as guaranteed, you're counting on the financial strength of the insurer to make those payments.

And since annuity payments are determined in part by the level of interest rates, there's another risk -- namely, that buying at a time when interest rates are low could relegate you to relatively low payments the rest of your life. But there are ways to deal with those risks.

To mitigate the chance that your annuity income could come to a halt if the insurer goes bust, you can stick to the annuities of insurers that get high financial strength ratings from companies like A.M. Best and Standard & Poor's. You can also diversify.

Split whatever money you intend to devote to an annuity among several highly rated insurers, and make sure the amount you put with any single insurer doesn't exceed the amount covered by your state's insurance guaranty association, which is typically at least $100,000.

To avoid investing your entire annuity stash when rates are at or near a low, you can invest over a period of several years instead of buying all at once. As for giving up access to the money you put into an immediate annuity, the solution is to limit the amount you put in.

For example, to get $1,000 a month today, a 65-year-old woman would have to invest just under $170,000. So if she were starting with $200,000, that would leave a bit more than $30,000 for emergencies and such.

If that reserve isn't enough -- and it may very well not be -- then she might figure how much income on top of Social Security she absolutely must have, and then devote just enough to the annuity to get that amount.

So, for example, if she figures that she can't feel comfortable unless she has, say, at least $600 a month coming in, then she could put just over $100,000 in the annuity -- enough to assure $600 a month for life -- and use the remaining $99,000 or so both to generate more income and as a reserve to tap whenever she needs extra dough.

Annuities certainly aren't for everyone. But if you're looking to create a secure income stream that won't run out, putting some of your money into an annuity while leaving the rest in conventional investments is a strategy you may want to consider.

One final note: Keep in mind that the purchasing power of $1,000 a month will decline over the years due to inflation. Assuming even modest inflation of, say, 2% a year, in 15 years you would need almost $1,350 a month to get what $1,000 buys you day.

By putting some of your money in an immediate annuity and the rest in investments such as stock and bond mutual funds, you have a shot at getting growth from the investment portion of your portfolio that can help maintain purchasing power.

You can learn more about how such a strategy might work by clicking here. Or you can stick with whatever investments you have that are now earning 4%, pull out that $1,000 a month, and see if your $200,000 grand actually makes it 27 years -- and whether you can live off $1,000 a month even if it does last. To top of page

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