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This blog started as an update on working during retirement. I quit full-time work over 10 years ago and have since worked on a limited basis.
I previously covered the basic principles of part-time work after Retirement in several blogs. For more information on the basics and benefits of part-time work after retirement see TRANSITIONING AWAY FROM FULL-TIME WORK: FINDING THE RIGHT BALANCE, THE GREAT DEPARTURE: CHOOSING BETWEEN SWIFT OR GRADUAL RETIREMENT, and A DECADE BEYOND THE CUBICLE: REFLECTIONS ON LIFE POST FULL-TIME WORK. So, I felt like I didn’t need to write another blog about the benefits of working part-time after leaving full-time work. But I also know there is a lot of misunderstanding about the benefits of working and the mathematical benefits of work-related income.
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In this blog, I’ll attempt to explain the financial benefit that part-time work provides and how that benefit relates to retirement savings.
Part-time work provides many benefits in addition to the income it provides. For many people, part-time work provides daily structure, social interaction, a sense of relevance, and a way to fill a now-empty calendar.
On the income side, I did not initially realize the importance of those extra dollars generated through part-time work. The basic concept is that each dollar earned equals $25 less needed in savings. This formula is derived using the 4% rule in reverse.
Now that this basic concept has been outlined, let’s examine and simplify it to make it more understandable.
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What is the 4% Rule?
The 4% rule is a basic retirement principle that states that 4% of money invested in a 60/40 portfolio can be withdrawn annually without totally depleting the portfolio over 30 years.
When utilizing the 4% rule, money is invested in a 60/40 portfolio where 60% of the portfolio funds are invested in an S&P 500 fund and 40% of the funds are invested in a Total Return Bond fund.
There are an infinite number of portfolio ratio variations, but the research on which the 4% rule was based used the 60/40 portfolio outlined above. Using this research, a retiree with a $500,000 portfolio could withdraw $20,000 annually (4% X $500,000= $20,000.)
It should be noted here that every year after the initial year, the annual amount is adjusted for inflation. If in year one inflation averaged 3%, then in year two the amount withdrawn would total $20,600 ($20,000 X 1.03 = $20,600.)
It should also be noted that simple math would indicate there would be a shortfall well before year 30. Taking a $20,000 withdrawal for 30 years would equal $600,000. A $500,000 portfolio would only last 25 years ($20,000 X 25 years = $500,000 with no adjustments for inflation.)
The 30-year timeframe becomes possible because the 60/40 portfolio has traditionally outpaced inflation and grown over the 30 years. This growth allows the portfolio to continue past the 25-year depletion period.
Financial advisors use a variation of the 4% rule to provide their clients with a rough estimate of the amount of dollars needed for retirement. These advisors reverse the 4% rule (using the fact that 4% equals 1/25 of a portfolio) and advise clients that they will need 25 times their highest earned income to provide the annual 4% withdrawal.
Using our same example. A person with an annual income of $20,000 would require $500,000 ($20,000 X 25 = $500,000) in retirement funds to implement the 4% rule based on guidelines. This same $500,000, as we just outlined, would provide an annual income of $20,000 using the 4% rule.
Each principle is the reverse of the other principle. What makes this concept important, and what I want to emphasize is each dollar generated through work-related income, passive income from real estate holdings, pension income or annuity income equals $25 less required in retirement savings.
In this illustration, a person receiving $1000 per month from any of the sources outlined above would have to have $300,000 saved ($1,000 X 12 months = $12,000. $12,000 X 25 = $300,000) to generate the same $12,000 annual income using the 4% rule.
When I retired from full-time dental practice, I felt I was adequately prepared for retirement and was financially independent. I currently continue working on a part-time basis. There are many reasons why I continued to work, but needing the extra dollars was not one of my primary reasons. After starting part-time work, I realized the importance of these surplus dollars in decreasing the burn rate and pressure on my retirement portfolio. Having work-related income before claiming Social Security benefits allowed my portfolio to remain virtually intact. The bull market returns of the last years have increased my Net Worth.
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Why is This Important?
For retirees who are overfunded (more money than needed) and constrained (adequate money), additional income can act as a buffer to reduce stress and depletion of a retirement portfolio.
For retirees who are underfunded, and have less money than necessary, the unfortunate reality is they will need to continue working to satisfy the shortfall due to a lack of adequate savings. For this group, the decision to continue working, full-time or part-time, may be more of a necessity than an option.
In both cases, the fact remains that every dollar of income generated equals $25 less in savings required.
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Final Thoughts
- Many people continue to work part-time after retiring from full-time work.
- There are many reasons to work part-time after retiring from full-time work, and many are non-financial.
- The dollars generated through retirement income can ease the strain on retirement savings.
- For underfunded retirees, work-related income (either full-time or part-time work) will help to plug the gaps in less than optimal retirement funding.
- Each dollar of income generated equals $25 less needed in retirement savings. These dollars can play a critical part in providing the retirement needs for many people who have not adequately saved.
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