Questions regarding spending are often best solved by determining the safe withdrawal rate. Our custom analysis based on a client’s specific situation is completed through the Retirement Spending Analysis bonus service, included at the Collaborative and Comprehensive service levels.

At our Do-It-Yourself service level, this analysis would cost an additional planning fee. However, we have attempted in this article to provide generic guidance on the topic.

Our safe spending rates are intended to provide sufficient inflation-adjusted income until the owner’s 101st birthday. You can read more about this decision in our article, “How Long Should I Plan On Living?”

1. Calculate your After-Tax Net Worth.

The first step is to use your age to calculate your after-tax net worth.

After-tax assets means that you would, at a minimum, discount traditional IRA assets by the total marginal state and federal tax rates. This is the value of the traditional IRA times one minus the sum of your top state tax rate (5.75% in Virginia) and your top federal tax rate.

If you wanted to do a full analysis like we do in our service, you would also discount the value of the unrealized gains in your taxable account by the total marginal state and federal tax rates. In this way, the after-tax value of your taxable account is the current value of your taxable account minus [(the current value of your taxable account minus the cost basis of your taxable account) times (the sum of your top state tax rate and your top federal tax rate)].

Roth assets already are after-tax. That is the beauty of them.

2. Account for Long-term Care Needs.

Once you have calculated the value of your after-tax retirement assets, the next step is to make sure long-term care needs are covered.

For those who are self-insuring for long-term care costs, meaning those who do not have sufficient long-term care insurance, it is important to set aside funds for those costs. You can read more about this in “How to Self-Insure for Long-Term Care Health Expenses (2022).”

We recommend that each person, regardless of whether they have long-term care insurance, look up their self-insurance number.

To calculate the numbers in the area where you will seek care, navigate to the Genworth study and enter the zip code into the relevant box. Click on the name of your area when it displays. This will give you the monthly median costs for various levels of service.

At a minimum, we recommend self-insuring for the cost of nursing home care for one adult for three years. To do this, click the “Annual” button to view costs of 12-months of care and make note of the cost of a semi-private room. Then, multiply this annual cost by 3.1 for a little more than three years. This result is how much you should set aside at age 85 for long-term care expenses.

In Charlottesville, VA, the result of this would currently be approximately $250,058 at age 85.

Next, if you have a long-term care insurance policy, gather your policy statement. Long-term care insurance normally has a maximum lifetime benefit limitation. This maximum limitation should be compared to the amount you just calculated.

Subtract the maximum lifetime benefit ($0 for those who don’t have insurance) from the calculated required savings. The difference between these two is the amount that we estimate you would need at age 85 to self-insure under your current insurance.

For those who have sufficient math or Excel skills to do so, the next step is to take your self-insurance number and discount it to today’s dollars. The self-insurance target will inflation-adjust over your lifetime and thus does not need inflation to be accounted for in the discount. However, you should check that your maximum lifetime benefit limitation has an inflation rider. If one is lacking, two separate discount formulas will need to be applied and then the difference recalculated.

The last step is to subtract the self-insurance target stated in today’s dollars from your after-tax assets.

3. Account for Other Non-Retirement Savings Goals.

This is the step where you account for other savings goals which you later won’t count in total withdrawals you compare to your safe withdrawal rate. Examples from clients include planning for a 10-year travel budget at the start of retirement, buying into a retirement community, or renovating the house.

The process here is the same as for long-term care insurance. Identify the dollar amount you need and the age you will need it. Then, discount the value to today’s dollars (excluding inflation assuming you state the costs in today’s dollars already). Then, subtract the result stated in today’s dollars from your after-tax assets.

4. Determine your Safe Withdrawal Rate.

While we calculate safe withdrawal rates down to the fraction of a year you are old, you can look up your closest safe withdrawal rate from our table in “Maximum Safe Withdrawal Rates in Retirement.”

There are reasons to customize that number to a specific individual. You can read about some of them in our series “Complete Guide to Safe Withdrawal Rates.” Some of those reasons include:

• Some of your retirement income sources are fixed (not inflation-adjusted), like a pension or annuity.
• Some of your retirement income sources are temporary and will end before age 101, like deferred compensation or royalties.
• Your withdrawals will start before some of your retirement income sources, like Social Security, will start.
• Some large current spending is temporary and will end before age 101, like your mortgage.
• Your asset allocation is overly conservative (more bonds than suggested) or overly aggressive (more stocks than suggested).
• and more!

Each of these situations requires an adjustment to either the safe withdrawal rate percentage or the value of the after-tax retirement assets in order to be accounted for.

5. Calculate your Safe Spending Rate.

The last step is to multiply the final value of your after-tax retirement assets by the final safe spending rate percentage and compare the result to your current spending.

If your current spending is larger than your safe spending rate, then the analysis is suggesting that you are overspending. Anytime overspending is identified, it is important to monitor the situation carefully.

Our analysis is sometimes overly cautious. For example, not everyone makes it to age 101 and not everyone has a long-term care event. Additionally, conducting the analysis at a low point in market returns can sometimes produce more pessimistic results.

Clients at the Do-It-Yourself service level or readers of the blog would retain responsibility for the task of analyzing and monitoring their spending, unless they hire us for the Retirement Spending Analysis bonus service. However, I hope that this surface level advice can steer you in the right direction.

When in doubt, seek the assistance of a financial planner.

Photo by Ben White on Unsplash. Image has been cropped.