How much can I spend in retirement without running out of money?
Read this advice from experts as quoted in the New York Times.
The 4 percent rule found that retirees who withdrew 4 percent of their initial retirement portfolio balance, and then adjusted that dollar amount for inflation each year would have created a paycheck that lasted for 30 years.
The concept has been both celebrated and criticized, and it has recently come under scrutiny yet again, particularly as the current crop of retirees are entering retirement during a period of historically low interest rates. But the question of how much they can safely spend each year may be more important than ever: Roughly 11,000 people, on average, are expected to turn 65 every day for the next 15 years, according to the Social Security Administration.
“I always warned people that the 4 percent rule is not a law of nature like Newton’s laws of motion,” said Mr. Bengen, who graduated from the Massachusetts Institute of Technology with a bachelor’s in aeronautics and astronautics in 1969. “It is entirely possible that at some time in the future there could be a worse case.”
Mr. Bengen’s original analysis assumed the retirees’ portfolio was evenly split between stocks and bonds, and he tested whether the paycheck could persevere through every 30-year period dating from 1926. It succeeded.
The big question now — difficult even for an aerospace engineer to answer — is whether a new worst case is beginning to play out, given the painfully low interest rate environment, which yields little for safer bond investments, where retirees often hold a big portion of their money.
The 4 percent rule found that retirees who withdrew 4 percent of their initial retirement portfolio balance, and then adjusted that dollar amount for inflation each year would have created a paycheck that lasted for 30 years.
The concept has been both celebrated and criticized, and it has recently come under scrutiny yet again, particularly as the current crop of retirees are entering retirement during a period of historically low interest rates. But the question of how much they can safely spend each year may be more important than ever: Roughly 11,000 people, on average, are expected to turn 65 every day for the next 15 years, according to the Social Security Administration.
“I always warned people that the 4 percent rule is not a law of nature like Newton’s laws of motion,” said Mr. Bengen, who graduated from the Massachusetts Institute of Technology with a bachelor’s in aeronautics and astronautics in 1969. “It is entirely possible that at some time in the future there could be a worse case.”
Mr. Bengen’s original analysis assumed the retirees’ portfolio was evenly split between stocks and bonds, and he tested whether the paycheck could persevere through every 30-year period dating from 1926. It succeeded.
The big question now — difficult even for an aerospace engineer to answer — is whether a new worst case is beginning to play out, given the painfully low interest rate environment, which yields little for safer bond investments, where retirees often hold a big portion of their money.
Strategies for Retirement Spending
Aside from the original 4 percent rule, retirement experts have devised more complex methods to help retirees determine what percentage of their nest egg they can safely spend each year for 30 years, without running the risk of entirely running out of money.
Assumptions: A 65-year-old couple begins with a $1 million portfolio consisting of 50/50 stocks and bonds. The strategies assume annual spending will never dip below $15,000 in inflation-adjusted terms over 30 years.
Withdrawals are increased each year to match inflation, except in years when the portfolio loses money. If the withdrawal rate ever rises to more than 120% of the initial rate, that year’s withdrawal is cut by 10 percent. In good years, withdrawals may increase by 10 percent.
Retirees begin by withdrawing a given percentage of their initial retirement portfolio. Each year thereafter, the withdrawal amount is increased to match the inflation rate.
In the first year, retirees withdraw a given percentage of their portfolio. After that, withdrawals could increase by up to 25% in bull markets, or decrease by not more than 10 percent in bear markets.
“Because interest rates are so low now, while stock markets are also very highly valued, we are in uncharted waters in terms of the conditions at the start of retirement and knowing whether the 4 percent rule can work in those cases,” said Wade Pfau, a professor of retirement income at the American College of Financial Services and another researcher within the financial planning community.
Since Mr. Bengen’s original paper was published, the 4 percent concept has been replicated, expanded, criticized and even refined by Mr. Bengen himself. (By using a more diversified portfolio, he later raised the rate to 4.5 percent).
Critics of the rule point out that it is based on conditions in the United States during a very specific time in history; it also doesn’t take into account items like investments costs, taxes, different time horizons or the reality that most retirees don’t spend their money in a linear fashion. Some people may want to spend more early in retirement and may be willing, even comfortable, making cuts when the market plunges once again. And if retirees want to leave money to their children, they may need to trim their spending further.
Sorting all of this out, particularly without a cushy pension to fall back on, is a complicated task, even for a numbers-savvy retiree. Still, the original 4 percent rule persists as a starting point, and some retirement experts are still comfortable suggesting similar withdrawal rates, with some caveats and new twists of their own.
In a recent analysis, Mr. Pfau compared several withdrawal strategies in an attempt to illustrate how spending patterns might change to guarantee that a portfolio will last for 30 years, even if low rates persist or retires face some other awful combination of events.
He found that people who spend a constant amount adjusted for inflation — similar to the 4 percent rule — would have to reduce that rate to 2.85 to 3 percent if they wanted assurance that their spending would never have to dip below 1.5 percent of their initial portfolio (in inflation-adjusted terms).
So a retiree with $1 million could securely spend nearly $30,000 annually for 30 years, in the best and worst of market conditions. The big drawback, though, is that if economic conditions are generally average, retirees would be left with $794,000 in unspent money. If they were unlucky and experienced terrible market conditions, they would be left with $17,900.
That’s the trouble with this strategy. “Most of the time, you underspend,” said Mr. Pfau, who is also a principal at McLean Asset Management. “Yet you still run the risk of running out.”
Other retirement experts, including Michael Kitces, director of research at the Pinnacle Advisory Group, are still comfortable recommending early withdrawal rates of about 4 percent. He has likened the current environment — low interest rates and high stock market valuations — to walking along a cliff. Today’s retirees are walking along the edge, which, he said in his blog, required more caution and continuous monitoring. But that doesn’t mean they’re going to fall off.
Mr. Bengen”s advice is this: “Go to a qualified adviser and sit down and pay for that; you are planning for a long period of time. If you make an error early in the process, you may not recover. ”
Assumptions: A 65-year-old couple begins with a $1 million portfolio consisting of 50/50 stocks and bonds. The strategies assume annual spending will never dip below $15,000 in inflation-adjusted terms over 30 years.
Withdrawals are increased each year to match inflation, except in years when the portfolio loses money. If the withdrawal rate ever rises to more than 120% of the initial rate, that year’s withdrawal is cut by 10 percent. In good years, withdrawals may increase by 10 percent.
Retirees begin by withdrawing a given percentage of their initial retirement portfolio. Each year thereafter, the withdrawal amount is increased to match the inflation rate.
In the first year, retirees withdraw a given percentage of their portfolio. After that, withdrawals could increase by up to 25% in bull markets, or decrease by not more than 10 percent in bear markets.
“Because interest rates are so low now, while stock markets are also very highly valued, we are in uncharted waters in terms of the conditions at the start of retirement and knowing whether the 4 percent rule can work in those cases,” said Wade Pfau, a professor of retirement income at the American College of Financial Services and another researcher within the financial planning community.
Since Mr. Bengen’s original paper was published, the 4 percent concept has been replicated, expanded, criticized and even refined by Mr. Bengen himself. (By using a more diversified portfolio, he later raised the rate to 4.5 percent).
Critics of the rule point out that it is based on conditions in the United States during a very specific time in history; it also doesn’t take into account items like investments costs, taxes, different time horizons or the reality that most retirees don’t spend their money in a linear fashion. Some people may want to spend more early in retirement and may be willing, even comfortable, making cuts when the market plunges once again. And if retirees want to leave money to their children, they may need to trim their spending further.
Sorting all of this out, particularly without a cushy pension to fall back on, is a complicated task, even for a numbers-savvy retiree. Still, the original 4 percent rule persists as a starting point, and some retirement experts are still comfortable suggesting similar withdrawal rates, with some caveats and new twists of their own.
In a recent analysis, Mr. Pfau compared several withdrawal strategies in an attempt to illustrate how spending patterns might change to guarantee that a portfolio will last for 30 years, even if low rates persist or retires face some other awful combination of events.
He found that people who spend a constant amount adjusted for inflation — similar to the 4 percent rule — would have to reduce that rate to 2.85 to 3 percent if they wanted assurance that their spending would never have to dip below 1.5 percent of their initial portfolio (in inflation-adjusted terms).
So a retiree with $1 million could securely spend nearly $30,000 annually for 30 years, in the best and worst of market conditions. The big drawback, though, is that if economic conditions are generally average, retirees would be left with $794,000 in unspent money. If they were unlucky and experienced terrible market conditions, they would be left with $17,900.
That’s the trouble with this strategy. “Most of the time, you underspend,” said Mr. Pfau, who is also a principal at McLean Asset Management. “Yet you still run the risk of running out.”
Other retirement experts, including Michael Kitces, director of research at the Pinnacle Advisory Group, are still comfortable recommending early withdrawal rates of about 4 percent. He has likened the current environment — low interest rates and high stock market valuations — to walking along a cliff. Today’s retirees are walking along the edge, which, he said in his blog, required more caution and continuous monitoring. But that doesn’t mean they’re going to fall off.
Mr. Bengen”s advice is this: “Go to a qualified adviser and sit down and pay for that; you are planning for a long period of time. If you make an error early in the process, you may not recover. ”
The excerpts above are from the article New Math for Retirees and the 4% Withdrawal Rule by TARA SIEGEL BERNARD from the New York Times.
To read the entire article click here
Expenses during retirement years increase substantially because of increased longevity
Life expectancy after the age of 65 continues to increase. This means that your health care costs will continue for 20+ years or more. In fact a couple both retiring at 65 in 2015 will have the expectation that one spouse is likely to live into her/his 90's. As a result your retirement savings must last much longer as your retirement expenses will be extended many more years than anticipated.
To read the entire article click here
Expenses during retirement years increase substantially because of increased longevity
Life expectancy after the age of 65 continues to increase. This means that your health care costs will continue for 20+ years or more. In fact a couple both retiring at 65 in 2015 will have the expectation that one spouse is likely to live into her/his 90's. As a result your retirement savings must last much longer as your retirement expenses will be extended many more years than anticipated.