Warren Buffett’s retirement income strategy: How a 90/10 rule could help a 65-year-old turn $600,000 into monthly income

A 65-year-old retiree with $600,000 in a traditional IRA could have nearly $4,800 a month to spend, including Social Security, while paying roughly $1,000 a year in federal taxes. The calculation is based on Warren Buffett’s famous 90/10 investment strategy. But there is a catch. Buffett originally recommended this mix for his wife, who would not need to regularly withdraw from her investments. For someone living on retirement savings, the same strategy works differently.

Buffett wrote the formula for someone who would never spend the principal

In his 2013 letter to Berkshire Hathaway shareholders, Buffett explained how he wants his wife’s money invested after he’s gone. He said his advice to the trustee “could not be more simple.” Put 10% of the cash in short-term government bonds, and 90% in a very low-cost S&P 500 index fund.

So take a more common case; a single 65-year-old with $600,000 in a traditional IRA and $2,800 a month from Social Security. Following Buffett exactly, the IRA holds $540,000 in an S&P 500 index fund and $60,000 in Treasury bills.

The fund Buffett has named more than once is Vanguard’s S&P 500 ETF. It closed Tuesday at $704.78 a share and has paid $7.43 a share in dividends over the past 12 months. That’s a yield of about 1.05%. Three-month Treasury bills yielded 4.21% as of Monday, according to Treasury data.

The $4,800 is the total monthly spending, Social Security included. That leaves about $2,000 a month from the IRA, or $24,000 a year. It works out to 4% of $600,000.

Now look at what the portfolio earns on its own. At a 1.05% yield, $540,000 in the index fund pays about $5,670 a year in dividends. At 4.21%, the $60,000 in Treasury bills earns about $2,500. Together that’s roughly $8,200.

The rest, around $15,800 a year, has to come from selling shares or bills. These are rough numbers, and they’ll move as prices and yields change. This is the real difference between Buffett’s widow and this retiree. She could live off what the money earned. A retiree who must spend $24,000 a year needs to sell part of the portfolio every year. When stocks are up, that’s painless. When they’re down, it isn’t.

The 10% in Treasury bills matters for that reason. It’s the money you spend from when the stock market falls, so you don’t have to sell shares at a low price. The $60,000 covers about two and a half years of withdrawals at this spending level.

The tax result is the surprising part. A traditional IRA withdrawal counts as ordinary income. Social Security, however, is only partly taxed, and how much depends on the person’s other income. A person aged 65 or older also gets extra deductions. Put together, the federal bill comes to roughly $1,000 a year. That’s federal tax only, and state tax isn’t included.

It changes at 73. That’s when the IRS requires withdrawals from a traditional IRA, known as required minimum distributions. These withdrawals are taxable income, so the bill goes up.

The plan’s one dangerous mistake is letting the bond cushion run out. If the Treasury bills are spent down and not refilled, the next withdrawal has to come from stocks, whatever they’re worth that day. Protecting that 10% is what keeps the plan working.