Several financial rules and guidelines can be applied to generating retirement income. A simple and popular strategy for those saving for retirement is the $1,000-per-month rule of thumb.
This rule of thumb helps you gauge how much you need to have saved in order to withdraw a certain amount monthly in retirement. Find out how it works, what pitfalls to watch out for, and how this rule of thumb compares with other retirement guidance.
- For every $1,000 per month in desired retirement income, you need to have $240,000 saved.
- With this strategy, you can typically withdraw 5% of your nest egg each year.
- Investments can help your savings last through a lengthy retirement.
- Younger retirees will have to plan on withdrawing less, however, to ensure their funds last.
What Is the Origin of the $1,000-a-Month Rule?
This rule of thumb was created by Wes Moss, an Atlanta-based Certified Financial Planner (CFP) and financial educator. He designed it to be a simple way to visualize how much in savings someone should accumulate if they plan to retire around age 65.
How Does the $1,000-a-Month Rule of Thumb Work?
The $1,000-a-month rule states that for every $1,000 per month you want to have in income during retirement, you need to have at least $240,000 saved. Each year, you withdraw 5% of $240,000, which is $12,000. That gives you $1,000 per month for that year.
Depending on your income from Social Security, pensions, or part-time work, the number of $240,000 multiples will vary. For example, if you want $2,000 per month, you'd need to save at least $480,000 before retirement.
When interest rates are low and the stock market is volatile, the 5% withdrawal aspect of the rule becomes even more critical. The market can go months or even years without a gain, and the discipline surrounding the 5% withdrawal rate can help your savings last through those tough times.
Grain of Salt
However, this rule of thumb does not apply to all retirees equally.
Based on the $1,000-a-month rule, someone at a typical retirement age of 62–65 can plan on a 5% withdrawal rate from their investments. But retirees in their 50s should plan on withdrawing less than 5% per year so funds last for the duration of a long retirement period.
In years that the market and interest rates are in a typical historical range, the 5% withdrawal rate works well, assuming you're 62 years of age or older. You must be willing to adjust your withdrawal rate in any year the market experiences a downturn or correction, though. You'll need to be flexible enough to adapt to the economic environment as it changes. However, in good years, you may be able to withdraw a little extra money, as long as it's not too much.
Inflation will also impact your retirement savings. If you're looking at retiring in 20 or 30 years, $1,000 won't go as far as it does now. The Federal Reserve strives to keep inflation to about 2% per year.
How to Increase Your Chances of Success With a 5% Withdrawal Rate
There are other factors to consider for the 5% withdrawal rate to be successful. For example, retirement often lasts for more than 20 years. You want to be able to withdraw 5% of your savings each year and not run out of money.
One way to do this is through income investing. With this investment strategy, you invest your funds in ways that will produce income. This might include buying stocks that pay dividends and investing in real estate investment trusts (REITs) and master limited partnerships (MLPs). MLPs are publicly traded and tend to pay higher dividends to investors.
Investing can help ensure your funds last through a lengthy retirement. If you withdraw 5% while earning no interest on your money, your funds will last 20 years. For many, however, retirement can last much longer, and exhausting your funds doesn't allow you to leave funds to family or charity.
If you have a portfolio yield of 3% to 4%, you may be able to withdraw 5% or more. For example, if your portfolio is earning a 4% yield from dividends and the markets rise by 3%, withdrawing 5% would be well below your annual gain of 7%. Any gains in the markets can help boost your portfolio and increase the chances of being able to withdraw 5% per year.
The $1,000-a-Month Rule vs. the 4% Rule
The $1,000-a-month rule is really a variation of the 4% rule, which has been a financial planning rule of thumb for many years. The 4% rule was first introduced by William Bengen, a financial planner who found that retirees could deduct 4% from their portfolio every year (and adjust for inflation) and not run out of money for at least 30 years. He said that retirees who had a mix of 50% stocks and 50% bonds and lived on about 4% or so each year would be unlikely to run out of money in retirement.
Like the $1,000-a-month rule, the 4% rule has some limitations. Not all retirees want a 50/50 mix of stocks and bonds, and some may need more or less money in a given year. These rules are just guidelines intended to ensure you save enough for retirement and don't withdraw funds too quickly.