Are you going to outlive your money, or is your money going to outlive you? If you retire at 66, your savings needs to last thirty years, until age 96. Is this a realistic time horizon? For illustrative purposes, DollarTimes.com crunched the numbers:
- Having saved $450,000, if you take annual withdrawals of $27,000 while earning 4.5% on your investment, your projected savings will last for 29 years and 11 months. In the last year, your withdrawal is $24,857, a difference of $2,143.
- Having saved $450,000, and taking $35,000 annual withdrawals, (just $8,000 more) your projected savings will last for 18 years and 10 months. In the last year, your withdrawal is $31,131, a difference of $3,869.
- Having saved $250,000, and taking $15,000 in annual withdrawals, your projected savings will last for 29 years and 11 months. In the last year, your withdrawal is $13,810.
The main question is: “Is this enough to live on?” Experts say you should plan to live on at least 80 percent of your pre-retirement income. Job coaches routinely remind young workers: “Make more so you’ll have more,” probably the best advice ever.
The 4% rule is actually the 4.5% rule
In theory, the 4% rule – withdrawing 4% of your savings during your first year of retirement, and then adjusting withdrawals for inflation going forward, might shine new light on previous withdrawal theories.
According to William P. Bengen, a retired financial advisor who first introduced the 4% safe withdrawal rate in 1994, the 4% rule is actually the ‘4.5% rule’ – the amount you could safely withdraw from a tax-advantaged portfolio like an IRA, Roth IRA or 401(k) the first year of retirement, with the expectation you could live for 30 years in retirement. “After the first year, you ‘throw away’ the ‘4.5% rule’ and increase the dollar amount of your withdrawals each year by the prior year’s inflation rate,” said Bengen.
Using $100,000 in an IRA at retirement as an example, the first year withdrawal is $4,500. At an inflation rate of 10% the first year, the second-year withdrawal would be $4,950.
Based on research Bengen conducted on investments and inflation going back to 1926, the withdrawal rates for retirement dates begin on the first day of each quarter, beginning with January 1, 1926. “The average safe withdrawal rate is, believe it or not, 7%!” Bengen said. “However, if you experience a major bear market early in retirement, as in 1937 or 2000, that drops to 5.25%. Add in heavy inflation, as occurred in the 1970’s, and it takes you down to 4.5%. So far, I have not seen any indication that the 4.5% rule will be violated.”
Bengen’s research also showed that both 2000 and 2007 retirees, who experienced big bear markets early in retirement, appear to be doing OK with 4.5%. “However, if we were to encounter a decade or more of high inflation, that might change things. In my opinion, inflation is the retiree’s worst enemy,” said Bengen.
Truth is, you cannot assume that using average returns and average inflation rates are correct methods for computing how much could safely be withdrawn over the duration. Establishing a sustained withdrawal rate is difficult to maintain from year to year, so adjustments are continually needed. There are determining factors to making your money last.
- Controlled Spending.During the accumulation phase, while you were working, and the distribution phase, while you are retired. Mortgage, tuition, special needs and elder care are included as big-ticket obligations.
- Overall health.Yours mostly, but spouse or family members.
- Miscellaneous.Tragedy, lawsuit, poor investment choices and market performance.
There is no way of knowing what life will hand us. So with proper income planning, a pension or 401(k), Social Security benefits and accumulated assets, the likelihood of running out of money is minimal, based on your savings, and within certain parameters.
Financial advisors wear a lot of hats these days
While the economy is fundamentally strong, and analysts are, at times, way too bullish, your advisor is the steady hand that guides you. He or she is both psychologist – managing fear, uncertainty and doubt – and tactical and strategic planning expert. It’s a big part of their fiduciary responsibility, and don’t take it lightly.
They must also pay attention to beta, sector weightings and asset allocation. So when rebalancing your portfolio, for example, they look out for your best interests, and for dividends and income, the types of things that stabilize a portfolio when the rest of the market is choppy.
In your annual review it’s a good idea to compare your investment portfolio to your ideal asset allocation – the right mix of stocks, bonds, cash, or other investments for your investment goals. Also, where you stand tax-wise. A wise man once said, “Don’t despair. If you have a huge tax bill, it means you are making money!”
Discuss making changes, too, by selling and buying shares of investments to realign your portfolio to your desired target; reducing your equities exposure, if you’re overweight equities, and adding high-quality fixed income to cope with market volatility.
If you’re retired, rebalancing is even more important because you need to know you’ll have a check every month, and that it’s going to be there, without seeing your balances dissipate. Know what is important to you and what it takes to protect your nest egg.
Have you ever heard of the “sleeping point?” It is taking just the right amount of risk that allows you to sleep at night. Sometimes, you buy or sell assets to maintain a desired level of asset allocation. Your Hefren-Tillotson advisor will discuss with you what changes he or she feels might be necessary for you to continue down the path of enjoying a secure retirement.