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Prospective retirees want a simple formula for making the retirement decision. Financial advisors, pundits, and salesmen would love to give it to them. And charge for it.

But, sadly, it doesn’t exist.

Sure, there are calculations that will shed light on your retirement prospects. You can gather your income, expense, tax, and investment return projections. Push that data into a retirement calculator and crank out a number showing how many years until you can retire, or how long your money will last.

It’s a fascinating exercise, and one I highly recommend for all potential retirees. If you don’t already have a favored tool, look at my list of the best retirement calculators.

Just don’t stake your future on the results. There is clarity at the extremes — if you have many millions, or nowhere near enough to retire. But, for most of us, there are too many unknowns to ever compute a precise numerical answer to the question of how much you need for financial independence.

For us, the retirement decision is not an entirely mathematical exercise. Rather, it’s a survey of the landscape ahead, and a gut check about our odds of navigating it successfully. In the face of that numerical uncertainty, you need a qualitative way to sum up your situation, deciding how much risk you can take on in retirement.

Because, assuming you have saved enough to be in range to retire, the real question is how aggressively can you withdraw from your portfolio in the retirement years….

Safe Withdrawal Rates

There is no precise answer to the retirement equation, but there is a numerical range. In my second book I write:

“There have been hundreds of studies into how much you need to retire, and nearly as many systems proposed for how to safely spend down your assets in retirement. In essence, these efforts break down into three categories: backcasting using market history, forecasting using history or current market valuations, and making like an endowment and consuming only the inflation-adjusted income and growth. [I go into more detail on these categories in the book.]

In the end, every one of these approaches boils down to this: A certain percentage of your assets is deemed safe to consume at the start of retirement. Sometimes that initial percentage is adjusted for inflation in following years, so the nominal amount withdrawn increases over time. Sometimes the percentage itself is maintained, so the amount withdrawn fluctuates and is proportional to the size of the underlying portfolio. Either way, each of these approaches settles on an initial withdrawal percentage.

And, after the better part of a decade studying and reading about this question, I can tell you that essentially all methods arrive at the same range of initial payout rates from your assets: between 2% on the very low side for the most conservative approaches, and 6% on the very high side, for the most optimistic approaches. Almost no responsible party currently recommends a withdrawal rate over 5% at the start of retirement. More and more are recommending lower rates – as low as 2% to 3%, given the state of world financial affairs, and unknown prospects for future growth.

If we throw out the outliers, we can say that the consensus view on this issue is 3% to 5%. Large endowments, respected financial companies, leading researchers, well-known financial advisors, best-selling authors, and successful early-retired bloggers all generally advise withdrawal rates within that range. “

Where Are You in the Range?

But, when it comes to retirement income, 3-5% is a very big spread. For example, suppose you needed $40,000 annually for retirement living expenses, in addition to any Social Security or pension. That 3-5% range is the difference between having to save $800,000 (if you use the more aggressive 5% withdrawal rate) versus having to save more than $1.3 million (if you use the more conservative 3% withdrawal rate).

When you retire, the choice is yours: You can start withdrawing 3% of your assets annually, or 4%, or 5%, or some in-between number. At the start, of course, you can get away with any withdrawal rate. You won’t see the impact on your portfolio for years, even in the worst cases. But, in the end, that withdrawal rate will determine how long your money will last. So how do you know which withdrawal rate is “right”?

Mathematically, as I’ve said, you don’t. But I made my retirement decision anyway, and you can too.

In recent years, I’ve been trying to “quantify” the non-numeric criteria that go into the retirement withdrawal rate decision. These are the factors that I used in making my own decision years ago, and that I recommend others take into account in making theirs.

What this boils down to is a qualitative system for balancing financial security and risk in retirement.

(I’d been kicking these ideas around in my head for years, but kudos to the Grumpmatic Method described in a recent guest post here, for crystalizing my thinking.)

Using my system is simple enough: There are a dozen factors that you need to evaluate and total up, all potentially favorable to a more aggressive withdrawal rate. You tally up your Retirement Flexibility Score, enter it into my simple scale below, and read out your suggested withdrawal rate.

Let’s get started by exploring each factor…

The Factors

For each of the following factors, if you can answer “YES”, add 1 to your Retirement Flexibility Score:

Do you have a plan for obtaining health insurance until age 65? (+1)

Sadly, health insurance in the U.S. can be a retirement deal killer. I was fortunate to marry a public school teacher with retirement health benefits. (We have to pay for them, but the group plan is guaranteed.) Then Obamacare appeared to offer an avenue for other pre-65 retirees to obtain coverage. But that avenue is changing and eroding now. Early retirees now may have no choice but to cast off for the unknown with the best plan being to re-evaluate annually, and pick up work if they must.

Could you go back to work in your original career in the first 4 years of retirement if necessary? (+1)

As I explain in the “Retirement Fuel Gauge” section of my book, a four-year window is a good safety check for your portfolio. Being able to return to your previous work is the ultimate backup plan. If things don’t go well in the first years of retirement, you can simply hit the “reset” button. Just understand that it’s the rare individual who could jump back into their career after much time has passed: the economy might have tanked which would impact hiring, your skills might have atrophied, or your job might have disappeared or changed due to technology.

Do you have the skills to start a lifestyle business that could bring in an extra $1-2K/month? (+1)

Many early retirees choose this route. A lifestyle business, related to a hobby or your previous professional skills — consulting, publishing, or coaching, for example — can offer freedom, creativity, and income. Just understand that small businesses are risky and hard work. There is no guarantee of success. (This blog required several years of dedicated part-time work to produce any significant income.) Whatever you do, don’t dump so much capital into a retirement business that it threatens your retirement!

Would you be willing to work a part-time service job to bring in an extra $1K/month? (+1)

Just $1K/month in extra income substitutes for about $300K in retirement savings, according to the simple 4% rule. Working in retirement, at a low-skill, hourly, part-time job is the most realistic way for most retirees to produce income in a pinch. And many people love the personal interaction, the flexible hours, and the minimal responsibility. Just make sure that having to pursue that kind of work would be an overall plus for you. If it’s necessary, but not enjoyable, why retire in the first place?

Could you reduce your discretionary spending by 50% for 3 years if necessary? (+1)

As I note in my book, to outlast a run-of-the-mill bear market, you need to improve your cash flow for about three years. Whether you are employable or not, cutting discretionary expenses is a route available to every retiree. Just ask yourself two questions: How much could I save by cutting? And, would it reduce my happiness so much that I’d rather be working instead? Cutting out international travel or new vehicles might not be much of a hardship. But foregoing visits to the kids or grandkids, skipping entertainment, or never dining out would be depressing for many.

Could you downsize to reduce your housing expenses by 25% or more permanently? (+1)

Another lever that many retirees can throw to cut their cost of living is to downsize their home. Do you really need the same size and location that you required in your working years, or while raising kids? In our case, we went from owning a 4BR single family home with yard in an upscale neighborhood in an Eastern city, to renting a 2BR duplex on a small, low-maintenance plot in an urban setting in a Southwestern town. Not only did downsizing save us some money, but it eliminated house maintenance as a wildcard financial variable. Further, the “lock it and leave it” lifestyle is a much better fit for our retirement years!

Is there at least a 50% chance that you’ll receive an inheritance that materially improves your net worth? (+1)

I wouldn’t generally count on an inheritance to fund my baseline retirement expenses. After all, it’s somebody else’s money, and you need them to die on schedule to fulfill your plans. Both unsavory factors. That said, if you have a good relationship with your parents, if they are well off, and if you have a handle on their health prospects, it would seem foolish to ignore a potential inheritance down the road. Rather than plugging a specific number into my calculations, I preferred to offset the uncertainty of an inheritance against the uncertainty in needing long-term care. Make your own best guess. These kinds of trade-offs are a personal matter.

Could you qualify for a reverse mortgage, and would it make sense for you? (+1)

With new research and new regulations, reverse mortgages have become more respectable. If you have substantial equity in your home, a reverse mortgage could improve your retirement income. But it’s wise to do some serious thinking and research in advance of any need. Are you old enough to qualify for a reverse mortgage? Will you be able to stay in your home long enough — while continuing to pay for taxes, insurance, and maintenance — for a reverse mortgage to make sense?

Could you purchase an annuity that would materially improve your lifetime income? (+1)

If you have significant retirement savings, an annuity can improve your apparent withdrawal rate. The fundamental tradeoff is leaving less wealth behind as a legacy. And there are other factors. Are annuity rates favorable when you need one? Do you have the liquid assets to buy one if required? Exactly how much extra income could you generate? And how would an annuity integrate with your Social Security and investment portfolio?

Is your retirement likely to be a traditional length (due to your age and/or health) of 30 years or less? (+1)

Most research tends to show a convergence in withdrawal rates in the 3-5% range, even for longer retirements. But the fact remains that, intuitively and mathematically, there is greater risk of running out of assets, the longer you must go without guaranteed income. A 10- or 20- retirement is a slam dunk for most people, often supporting withdrawal rates in excess of 5%. A 40- or even 50- year retirement, statistically likely for early retirees, is another matter. For those time spans, you’d better monitor your portfolio carefully, consider a withdrawal strategy that preserves principal, and possibly supplement with some part-time work income.

Are stocks reasonably valued on your retirement date: Is the Schiller PE Ratio (CAPE) near to or lower than its long-term average? (+1)

There are researchers out there who will tell you, based on current market valuations, exactly what your safe withdrawal rate (SWR) should be. I’m not so sure that we can predict the future accurately based on the past. Pundits have been calling for a market downturn for essentially my entire retirement since 2011, and yet my portfolio has kept going up. Still, conservative, defensive investing is part of my DNA. And this factor is a nod to the notion that if stocks are priced high now, you may not be able to count on your portfolio as much in the future.

Does your bucket list — professional or recreational — outweigh the security of staying in your old career? (+1)

In my view, this is an absolutely critical component of the retirement decision. Call it the “mirror” factor: When you look in the mirror in the morning, are you happy with your life? Most people worry about outliving their money. That’s a valid concern. But it’s not the only one. In the final years of my career, I worried as much about underliving my life. I didn’t want to die or lose my mobility before I’d done a lot more traveling and outdoor adventuring. Those activities, and the associated personal relationships, were what made my life worth living. And I was at risk of running out of time if I kept slaving away at my career into my 60’s.

The Scale: Your Safe Withdrawal Rate

If you followed the steps above, you should now have your own personal Retirement Flexibility Score somewhere in the range of 0 to 12. We’ll now map that score into the 3-5% withdrawal rate range like this:

Using the above table is simple: Scan down the left side for your score, and read the suggested safe withdrawal rate in the right column.

The essential insight here is that the more qualitative financial and lifestyle factors in your favor, the more aggressive a potential withdrawal rate you can live on in retirement. On the other hand, the less flexibility in your life, the more conservative your withdrawal rate ought to be.

And it’s all predicated on the common sense idea that if your retirement isn’t going well down the road using the withdrawal rate you chose at the start, you would employ these factors to reduce your withdrawal rate.

Caveats

Have I calibrated or weighted my factors against each other? Have I back-tested my results? Have I performed randomized trials on real retirees? No, no, and no.

This scoring system is an informal tool, a thought experiment. Don’t read too much into it. It represents only my rough experience, based on years of reading, thinking, and writing about retirement modeling, early retirement, and retirement income, and nothing more.

This is by no means a precise scientific method, proven to work in the past or guaranteed to work in the future!

Use it, if you do, as only one of many tools for guiding your retirement decision….

Conclusion

How much money do you need to retire? As I discuss in my book, there are a range of answers to that question.

In my opinion, if you can live on about 3% or less of your starting assets annually, you have enough already. On the other hand, if you’d need more than about 5% of your assets, you don’t have enough for a realistic shot at financial independence — you need to work longer, or live on less.

But what about in-between those two numbers, where many of us will find ourselves making the retirement decision? What if you have more than enough to live on a 5% withdrawal but not enough to make it on a 3% withdrawal?

The question for you then is not how much money, but how much risk are you willing to take on? Your retirement might work out OK. Or it might go off the rails and you’d have to make adjustments. It depends on your flexibility and your resources.

My Retirement Flexibility Scale can help you answer that question.

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Note: In keeping with our new policy on the blog, the comments section below is now open. We welcome civil discussion. I won’t be able to reply personally to most comments, but Chris will be moderating.

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