A well-known joke about retirement spending came to mind as I read a recent article.
First Person: How are you set for retirement income?
Second Person: I’ll be fine as long as I die by Friday.
Yes, I have a dark sense of humor.
Laughing in the dark
But with interest rates on savings at near zip, disappearing dividend yields and widespread angst over bubbles in everything from houses to stocks to used cars, a little dark humor strikes me as quite healthy.
What else can we do but laugh in the dark?
The article, written by Christina Benz and John Rekenthaler at Morningstar and supported by a very comprehensive review of safe withdrawal rates for retirement portfolios, tells us that taking spending money from retirement savings can leave you broke if you spend at more than 3.3 percent a year, inflation adjusted.
Lost retirement dreams
That’s not much.
It’s low enough to crash a lot of retirement dreams, maybe most.
To be sure, the authors bend over backwards to say there are ways to push that figure back to the 4 percent-plus that we learned was safe back in 1995, but most people simply won’t want to do all the required tinkering and heavy lifting on their own.
There are some takeaways, however, that can help us keep the whole thing to a Couch Potato investing project.
Rule #1: The middle road in asset allocation is the best road.
Now, as in earlier studies of portfolio survival rates, it turns out that you can’t go too far wrong with a 50/50 split between stocks and bonds. Hold more stocks than bonds, and the ups and downs of stock prices have a greater chance to kill your portfolio. But if you hold more bonds than stocks, inflation will do the killing.
Advisers can argue over being 60/40, 50/50 or 40/60, but the fees they charge will likely be larger than any difference they might make. In a 25-year period, for instance, the Morningstar paper shows a safe withdrawal rate spread from 3.4 percent to 4 percent for allocations from 100 percent stocks to 100 percent bonds. For spreads from 70 percent stocks to 20 percent stocks, the safe withdrawal rate is stuck between 3.9 and 4 percent. That’s a spread of one-tenth of 1 percent.
Clearly, paying for magical asset allocators is a losing game. You’ll get the most bang (and spendable income) for your buck by minimizing investment expenses with index funds and having a 50/50 mixture of stocks and bonds.
Rule #2: Required minimum distributions are the way to go.
There are several methods for safely increasing your annual spending, but they ignore one crucial fact: Most retirees have most of their money in retirement accounts. If you owned a business and sold it, you might have most of your assets in regular taxable accounts, but for most people the elephant in the asset room is your 401(k) or other tax deferred plan.
Like it or not, your annual withdrawals are dictated by the IRS.
People with lots of money like to grumble about this and feel burdened by their tax bills. But most people spend most of their retirement wanting to take more than the required minimum distribution from their accounts.
The downside to required minimum distributions is that they will fluctuate more than the distribution methods that you can’t use. That can be a bother, but it is offset by a big benefit. Since required minimum distributions are based on life expectancy, you will never run out of money. You may have less retirement income than you hope, but you won’t go broke.
Rule #3: The safer you get, the more money you’ll leave behind.
Confirming what researcher Michael Finke identified years ago, the study found that there was a direct relationship between the safe withdrawal rate and the amount of money left at the end of 30 years. If you want to be certain that you won’t run out of money ninety percent of the time, it will also be certain that you’re going to leave lots behind 90 percent of the time.
Required minimum distributions provided the highest spending rate and the lowest asset balance at the end of 30 years. You may not be able to Go Big. But you can go bigger.
Rule #4: The angel of death is a big fudge factor in your favor.
The standard of safety in safe withdrawal rate research has been a portfolio that survives 30 years of withdrawals 90 percent of the time. The study mentions the fact that 30 years is a lot longer than most people live after retirement at age 65. Unfortunately, the study doesn’t do anything with that fact.
But our mortality has a big impact on whether we’ll actually experience running out of money due to our spending rate.
According to financial planner Michael Kitces’ joint life expectancy and mortality calculator, for instance, a 65-year-old man and woman have only a 1 percent chance both will be alive at age 95. There is an 84 percent probability both will be dead. And a 16 percent chance that one of them will still be alive.
This means we’re really talking about only a 1.6 percent chance that anyone will live to see the 10 percent failure.
As retirement researcher Michael Finke pointed out long ago, you’ll only experience going broke if your portfolio fails AND you’re still alive.
Accept a 20 percent failure rate and there is a 3.2 percent chance one person will be alive to experience it – but the withdrawal rate will have increased from 3.3 percent to 3.9 percent.
That looks like a good bet.
Sidebar: A Required Minimum Distribution Reader
Scott Burns, “Required minimum distributions, not such a bad thing after all,” 3/3/2014 https://scottburns.com/required-minimum-distributions-not-such-a-bad-thing-after-all/
Scott Burns, “How to overcome fear of required minimum distributions,” 9/28/2014 https://scottburns.com/overcome-fear-of-required-distributions/
Scott Burns, “Falling in love with required minimum distributions,” 6/29/2019 https://scottburns.com/falling-in-love-with-required-minimum-distributions/
Scott Burns, “The graceful, soothing curve of RMD income,” 6/19/2021 https://scottburns.com/curve-of-rmd-income/
Scott Burns, “Another way to use required minimum distributions,” 10/9/2021 https://scottburns.com/the-beauty-of-required-minimum-distributions/
Scott Burns, “Life: How much will you leave on the table?” 4/8/2012 https://scottburns.com/life-how-much-will-you-leave-on-the-table/
Scott Burns, “Live Long, Spend Freely,” 3/20/2016 https://scottburns.com/life-how-much-will-you-leave-on-the-table/
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Sources and References:
Christina Benz, “What’s a safe withdrawal rate for the decades ahead?” 11/11/2021 https://www.morningstar.com/articles/1066569/whats-a-safe-retirement-spending-rate-for-the-decades-ahead
Access to Morningstar research paper, “The State of Retirement Income: Safe Withdrawal Rates,” https://www.morningstar.com/lp/the-state-of-retirement-income
Michael Kitces: Joint life expectancy and mortality calculator: https://www.kitces.com/joint-life-expectancy-and-mortality-calculator/
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo: Scott Burns 2021
(c) Scott Burns, 2021