Making your money last in retirement

We all have different retirement goals. However, having your money last as long as you need it is a common goal we share. In our 50 years of working with IBEW members, we regularly help members with questions such as:

• How much can I safely withdraw from my account every year without running out of money?
• How do I cover my basic living expenses and maintain my lifestyle including travel and other hobbies?
• When is it okay to spend this money, and when might it be damaging to the long-term survival of my portfolio?

While there is no magic formula to help ensure that you don’t outlive your assets, much research has been done to develop processes and strategies to determine a safe withdrawal rate. The research aims to balance two conflicting priorities in retirement: lifestyle needs and longevity risk. The idea is to have retirees sufficiently prepared to take withdrawals through the remainder of their lives, while also being able to maintain their lifestyles.

Your withdrawal rate is calculated by dividing your annual withdrawal amount by your account balance. For example, if you withdraw $21,000 per year ($1750 per month) and your account balance is $525,000, your withdrawal rate is 4%.*

A safe withdrawal rate is the amount of money that you can withdraw from your investments each year, with the ability for future year’s withdrawals to increase with inflation and with a high probability that your money will last the remainder of your life expectancy, even if investments are delivering below average returns.

Planning to have enough money in retirement begins first with having a budget. Therefore, Scarborough’s retirement planning process starts with itemizing all of your anticipated retirement expenses, ranging from essential living expenses to discretionary spending. Once the income need is established and other sources of retirement income (such as Social Security) are reviewed, a plan can be produced showing how much money you can withdraw and how long it may last.

The key to help make your account last is not how much you have, but how well you manage your cash flow. Without a budget and a sustainable strategy, it is much more likely that you will go through your money and not have enough to last.

One method used by many financial professionals to give guidance on how much you can safely withdraw from your investments is called the “4% Rule”. According to the rule, you would take 4% of your total portfolio in the first year of your retirement and increase the amount each year by the rate of inflation. The benchmark, developed and published in the Journal of Financial Planning in 1994 by William Bengen, was based on average returns of overlapping 30-year periods, using a model portfolio with a 50% allocation to stocks and 50% to bonds.

Research supporting the soundness of the 4% Rule shows there is a good chance that your money will continue to generate retirement income for at least 30 years. An advantage of this simple strategy is that it should be predictable; you know how much you will have to spend each year.

While the 4% Rule is still the benchmark used by many financial professionals, other planners feel that one’s strategy must be more flexible in order to be sustainable. Today, people are living longer and need to be prepared for the possibility of living beyond 30 years in retirement. Additionally, the 4% Rule assumes your investment returns will equal historical averages for stocks and bonds. But historic averages don’t necessarily reflect the conditions you face out of the retirement starting gate and these initial conditions can have a significant effect on where you end up. If you start taking withdrawals from your portfolio at the beginning of a bear market, you could face a higher risk of running out of money than if you start tapping money when the market is healthy.

Despite these concerns, the 4% Rule is still a good rule of thumb for general guidance. It is important to note, however, that there is no one rate or strategy that will work for everyone. To determine an appropriate withdrawal rate, your age, life expectancy, living expenses, income sources, asset allocation and investment returns should be considered.

It is generally recommended that you have 40% to 60% in stocks at the start of your retirement with the rest in cash and fixed-income investments. This stock exposure is important to keep pace with inflation. However, some retirees are fearful of the ups and downs that come with stocks and invest more conservatively, perhaps 25% to 30% in stocks. In these cases, a withdrawal rate of 3% may be more appropriate.

Lower initial withdrawal rates may also be recommended if you expect to spend a longer time in retirement (due to a younger retirement age or family history of longevity) or have a strong desire to leave money to your beneficiaries.

Meanwhile, having greater lifetime income from guaranteed sources (Social Security, traditional pensions, annuities, etc.) permits retirees to raise their withdrawal rates. Increasing age and therefore lower expected life span also allow retirees to raise their withdrawal rates.

In recognizing that the 4% Rule is a good starting point and considering the realities of current times, it makes sense to leave room for flexibility. Ideally, any spending rule will make adjustments in your retirement income along the way to reflect how much money you have left and how long you expect to live.

For participants who retired 10-20 years ago, your withdrawal strategies were established during a different economic environment. Current interest rates and projected investment returns could warrant a fresh review of your withdrawal strategies.

One of the worst mistakes you can make during retirement is withdrawing too much, too quickly from your accounts. If you spend down your money while you’re retired but could have worked and then run out of money at an age when you can no longer work, you are left in a very difficult situation. We recommend having a formal plan for withdrawing money to help insure your money lasts throughout your retirement. It may seem obvious, but it is key that retirees not withdraw more than they can afford and that they maintain some level of discipline in their spending.

Despite our warnings, some people withdraw at unsustainable rates. While some circumstances are unavoidable, other decisions should be strongly considered for the long-term health of your retirement plan. Purchases that were not affordable during your working years may not be affordable now even though there is a large lump sum of money. This money needs to last a very long time!

For those who retired under age 55 and are receiving SEPP (72t) payments, making additional withdrawals should be given even more consideration because of the substantial tax penalties involved.

At Scarborough, our goal is to help you put together an investment and withdrawal strategy within the Plan to help achieve a high level of confidence that your money will last. Your withdrawal rate is a key factor in determining how long your retirement investments will last. As part of our account review process, we discuss your withdrawal rate with you and make suggestions if necessary. Please call us if you would like to discuss your withdrawal rate in more detail.