How to Not Run Out of Money in Retirement

Two people retire with the same $1 million, spend the same amount, and earn the same average return.

Ten years later, one has about $205,000 more than the other.

The only difference is the order the good and bad years arrived in.

The real risk is a bad start

While you are working, a market crash is almost a gift. You keep buying, and you buy cheap.

In retirement it flips. You sell a little every year to pay your bills. When prices are down, you have to sell more shares to get the same money. Those shares are gone, so they are not there when the market comes back.

Here is the example. Both retirees start with $1,000,000 and take out $40,000 at the start of each year. Over ten years, both get the same ten yearly returns: two bad years, down 20% and then down 10%, and eight good years of about 9.4% each. The average is 4.5%. One gets the two bad years first. The other gets them last.

After ten years, the one with the bad years at the end has about $1,058,000. The one with the bad years at the start has about $853,000.

Same money, same spending, same average. A gap of about $205,000, just from timing.

So the years just before and just after you retire matter more than any others. You cannot choose when the bad years come. But you can set things up so a bad start does not force you to sell. That is what the three defenses below do.

Defense 1: A cash cushion you build before you retire

The idea is simple. In the last few years before you retire, you slowly set aside money in something safe. In your first years of retirement, you live from it whenever the stock market is down.

A simple schedule, counted in months of living costs:

Five years before retirement: 3 months of expenses.

Four years before: 6 months.

Three years before: 9 months.

Two years before: 12 months.

At retirement: 24 months.

If you spend $60,000 a year, that ends at $120,000: two full years of living costs that do not depend on the stock market.

The rule is just as simple. In a year when stocks are down, you live from the cushion and sell no stocks. In a year when stocks are up, you take your spending from stocks and fill the cushion back up.

Where to keep it: somewhere safe that still pays interest. One easy option is SGOV, a fund that holds very short US Treasury bills, the loans to the government that are paid back within three months. Its price barely moves, its yearly fee is 0.09%, which is $9 on every $10,000, and its interest is usually free of state income tax. A Treasury money market fund at your brokerage works just as well.

Why two years? In US stock market history, the average drop from peak to bottom has lasted about 10 months. Getting all the way back to the old high usually takes longer. Two years will not cover every crash, but it covers most of them.

The cushion can shrink later. Studies of past markets found that retirees did better when they kept more of their money safe in the first years and then put more back into stocks once that risky stretch was over. So after about five years of retirement, you can let the cushion get smaller, for example down to 12 months, and keep the rest invested.

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Defense 2: Spending that can bend

Most retirement math assumes you spend the same amount every year, plus a raise for inflation, no matter what the market does. Almost nobody actually lives like that.

Split your spending into two parts.

Must-haves: housing, food, insurance, utilities, healthcare. These get paid every year.

Nice-to-haves: travel, gifts, eating out, the new car that can wait a year.

Say you spend $60,000 a year and $15,000 of it is nice-to-haves. In a bad year, you skip your inflation raise and cut the nice-to-haves by a third. That takes $5,000 less out of your savings while prices are down, and you give up nothing you need.

It sounds small. But selling less when prices are low is exactly what protects you from a bad start.

Write a simple rule down now, while markets are calm: if your savings start the year more than 15% below their highest point, no raise and a smaller travel budget. When they recover, both come back.

Defense 3: A home without a mortgage

The cheapest income you will ever have is a bill you no longer pay.

Say your mortgage is $2,000 a month. That is $24,000 a year your savings have to produce. A common rule of thumb is to take out about 4% of your savings each year. At that rate, covering $24,000 takes about $600,000 of savings.

And if that money comes out of a traditional 401(k) or IRA, you pay income tax on it first. In the 12% tax bracket, paying $24,000 of mortgage takes about $27,300 of withdrawals.

Pay the house off and all of that goes away. You need less each year, you withdraw less, and a lower income can also lower your Medicare premiums and protect any health insurance help you get.

Two cautions. Do not empty your cash cushion to pay off the mortgage early, because cash during a crash is worth more than a smaller loan. And if your mortgage rate is very low, paying it off is more about peace of mind than math. Both are good reasons. Just know which one you are choosing.

How the three work together

Picture the bad start from the top of this piece. Stocks fall 20% in your first year of retirement.

With the cash cushion, you do not sell a single share. You live on the safe money.

With flexible spending, you need less from the cushion, so it lasts longer if the second year is bad too.

With no mortgage, the amount you need was smaller to begin with.

None of these is complicated. Together, they turn a crash in your first year from a threat to your whole plan into a year you get through and then refill.

What this does not fix

Three things still need their own plan.

Rising prices. Over long periods, Treasury bills have barely kept up with inflation, so the rest of your money still needs to be invested to grow. The cushion protects you. It does not grow your wealth.

A very long life. Waiting to claim Social Security is the cheapest protection there is. For every year you wait past your full retirement age, up to age 70, your check goes up by 8%, for life.

Taxes. Which account you take money from each year changes how long it lasts.

Your checklist

Write down your must-have and nice-to-have spending as two separate numbers.

Count the years to your retirement date, and start the cushion at the right step.

Pick where the cushion lives: SGOV or a Treasury money market fund.

Write your bad-year rule down now, while markets are calm.

Decide what you want to do with the mortgage before you retire, not after.

Running out of money is rarely about how much you saved. It is about being forced to sell at the wrong time. Take that away, and most of the risk goes with it.

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Which of the three do you already have in place? Tell me in the responses, and follow along for more on keeping what you build.