“One of the thorniest issues facing retirees is how to determine much money they will be able to spend when they no longer work. Even data-focused planning has a hard time solving the dilemma of knowing exactly how much to withdraw without compromising one’s lifestyle.” Paul Hubbard III
A persistent concern of those at or near retirement is the risk of outliving their savings. “How much can I withdraw each year without running out of funds?” is a common question that has retirees and pre-retirees tossing and turning at night. Finding the perfect answer to this question is more challenging than figuring out how much money a person needs to save during the accumulation phase of retirement. Unfortunately, the consequences of spending too much (or even too little) are often severe, even for those who are fortunate enough to receive pensions.
Shifting demographics, increased life expectancies, government policies, and a lack of financial literacy have contributed to what some financial experts call “decumulation” worries, calling into question conventional strategies, such as the “4% rule.” William Bengen’s famous “4% rule” was formulated based on historical market returns and expressed the idea that a retiree could spend 4% from a balanced portfolio in year one, then increase that payout annually to keep pace with inflation without running out of money.
Many advisors, however, are suggesting that a 3% spend-down rate is much safer and sustainable. Other experts concerned about using future returns based on past market returns say that planning should rely on statistical distributions for expected future returns. There is also widespread concern among planners about the so-called “sequence of return risk,” a situation where you have substantial losses early in retirement. The sequence of return risk, along with increasing annual withdrawals, could potentially lead to depleting one’s savings long before retirement ends. Some plan designers suggest a floor/ceiling modification of the 4% rule to offset these risks.
Another common way advisors answer how their clients should approach spend-down is to run thousands of scenarios to evaluate the probability of depleting a retirement account. This decumulation strategy is called the “Monte Carlo” method. The Monte Carlo method is something of a set it and forget it method that many seniors find unappealing for various reasons.
Finally, some decumulation experts propose a more straightforward and conservative means of creating the ideal planning horizon for a healthy individual. These decumulation plans seek to alleviate the risk of healthy 65-year-olds building time horizons that are either too long or too short. In this approach, you still use a conservative planning age. However, you eliminate market and inflation risk by laddering various safe money and income products such as TIPS, annuities, or other vehicles. Many retirees decide to simply outsource the income decision to a risk bearer and buy an annuity to provide the income. This approach has also caused less worry and stress for many retirees.
Bottom line: Spending down the money you’ve worked so hard to accumulate can be a tricky process. Decumulation plans that are either too aggressive or too conservative carry potential risks. While there is no one perfect approach to spending the right amount of money in retirement, various options are available, depending on your unique situation and risk tolerance. It would be best to sit down with a retirement and income specialist who can help you discover which method will work best for you.
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