(As always, click on a chart or table to see a larger version. Hover your mouse over any yellow text.)
Here's the chart from that second post showing the cost of forgone savings without the simultaneous cost of early spending, in other words, imagine a retiree who could stop saving, retire, and avoid spending savings until age 70. (Note a minor change to the chart from my last post: this one graphs balances at the beginning of each year whereas the last post assumed the worker retires at the end of the year.)
Typically, however, when a worker retires and stops saving for retirement, he also begins spending from savings. Chart 2 below shows the resulting portfolio balances when a retiree simultaneously stops savings and starts spending at a given retirement age. It also shows the amount of spending supported assuming a constant-dollar annual withdrawal of the portfolio balance at the retirement age.
The amount of the sustainable withdrawal percentage is calculated using Milevsky's formula for sustainable spending (download PDF) using the life expectancy from the "male" columns of the following table. Note that females have slightly lower SWR's because they have longer life expectancies. My first post on this topic noted that the longer you postpone retirement, the greater your expected savings will be and the larger the percentage you can safely spend annually.
A lot of this difference comes from the huge growth in the portfolio the last few years of retirement resulting from compound earnings. These portfolios grow exponentially and each year that you delay spending affects your savings balance more than it did the year before. (This is why most financial planners urge you to be very cautious with your investments the last decade of your working career.)
A substantial amount of the sustainable spending difference also comes from the increased SWR – the retiree gets to spend a larger percentage of a larger portfolio. In this example, the additional spending increases $21,269 a year from a larger portfolio at retirement and another $10,278 from an increased SWR.
This scenario is an example and there is no guarantee that your portfolio will grow at all in the final five years of your career, let alone that it will grow as much as 7% annually. The intent is only to show how changes in retirement age affect retirement spending. How much it affects spending depends on market returns and life expectancy, things we can't predict.
The earlier you retire, the less money you can spend after you retire. A significant portion of the reduction of retirement spending can be attributed to the fact that you stopped saving earlier, and a larger portion of additional cost is attributable to spending savings earlier. Toss in the lower sustainable spending amount at younger ages because we have to plan for a longer retirement and the body blows add up quickly.
So far, those body blows from retiring early include:
- a longer (and consequently more expensive) retirement,
- fewer years to save,
- lost returns on those forgone savings,
- lost returns on savings that we spend at an earlier age, and
- a lower sustainable withdrawal rate (or life annuity payout) due to the longer expected lifetime in retirement.
Note: The assumptions for these calculations are the same as in the initial post, The Risk of Retiring (or Being Retired) Early. I assume the worker will earn the "typical" annual incomes shown in the charts in that post and will save 10% of earnings every year. I assume he or she will earn a consistent 7% annual return on all savings (an optimistic assumption in current capital markets). All calculations are in nominal dollars except for expected market returns used for the Milevsky formula, for which I assume a 5.6% real annual return with 11% standard deviation.