By Professor Rick Ulivi, Ph.D.
“I just don’t want to run out of money in my retirement!”
In my more than 30 years as a financial advisor, I have heard this – or some version of it – from client after client. It’s understandable. After all, who looks forward to a retirement that depletes a nest egg far too early?
Truth be told, if this is the only concern on your mind regarding your retirement, the answer is really quite simple. You need only radically minimize expenses to extend your savings as long as possible. But who wants to do that?
You didn’t save for years and years during your career to let your money sit in an account while you pinch pennies. You want your money working for you as a resource for attaining your vision for retirement.
This is the tension that so many face–how to utilize their money now, while at the same time remaining confident it will be there throughout their lifetime. This tension is best illustrated by this question:
“How much should I withdraw from my retirement portfolio each year and still be sure, or at least very confident, that I will not outlive my money, and that I may even have some left for an inheritance if desired?” If you set the withdrawal rate too high, you will run out of money prematurely. If it is set too low, you’ll miss out on some of the joys of life.
An Analysis of a Retiree’s Dilemma
Let’s assume you are about to retire or are recently retired, and you would like an annual income of $80,000. Suppose your house is paid for, and you will get about $40,000 in combined SS and another $10,000 from a pension. This totals $50,000, which means you are short by $30,000 to maintain your lifestyle. Fortunately you have saved $700,000 in an IRA. The dilemma I mentioned now becomes real. How much should you be withdrawing each year from your portfolio such that it:
- Never requires a reduction in withdrawals from any previous year
- Allows for systematic increases in withdrawals to offset inflation
- Maintains your withdrawals for at least 30 years or leaves an inheritance
The 4% Withdrawal Rule
The often heard solution to this dilemma is the widely accepted 4% rule. It basically says that a well diversified portfolio, subjected to an initial 4 percent withdrawal, and adjusted for annual inflation thereafter, would provide income for at least 30 years in almost all scenarios. Applying this rule would allow our retiree to take out $28,000 from the IRA and increase it annually by the rate of inflation. Right? No so fast. The dilemma is a lot more complex than the simple 4% rule. That’s because a lot of variables impact the ability of a portfolio to allow for an ever increasing withdrawal of income. Some of these are:
- Life expectancy. The longer you live, the less you can withdraw each year. The shorter your longevity, the more you can take out each year. The key is to predict how long we will be around, and that’s very difficult to do. What if you or your spouse lives to be over 100? After all, life expectancy has increased 50% over the past 100 years, and the number of Americans who live beyond age 100 increased 43% from 2000 to 2010. The 4% rule will lead you to go broke way too early. And then what?
- Health care expenses: What if you get hit with a long term care illness, like Alzheimer’s? That alone may cost twice your expected annual income, and for an extended period. What will this do to your savings?
- Inflation: What if these two increase faster than the historical figure, and all of a sudden your income cannot maintain its purchasing power? Who knows what the future consequences of Bernanke’s easy money policy will be?
- Your desire to maintain or deplete your capital: Some retirees take the attitude that they want to spend it all in their lifetime; that’s well and fine, but some want to leave a large inheritance to their loved ones, for their own reasons. Each of these choices has a great impact on your planned withdrawal rate.
- Social Security and Medicare: Will the benefits 20 years from now be as good as they are now? Do you know what happened to retirees in Greece, Portugal and Spain? Sure, the USA is not like one of these countries, at least not yet. But what about 20 years from now; you might still be around, but will SS be as generous as it is now? Think about what is likely to happen to the retirees in Detroit. For those of you who are not following the saga, the city is trying to declare bankruptcy and pay retirees 10% of what is owed to them. Shocking to read about–devastating if it affects you. Could this happen to SS?
- Rate of return on investments. While it is very easy to project a rate of return of xx% for 30 years, the reality may be totally different. It is impossible to predict what your actual rate of return will be, yet the 4% rule assumes you will earn a safe and generous rate of return for decades. This may be a reckless assumption.
Uncertainty is your greatest risk
We can make all sorts of assumptions and projections, and develop likely cash flow and investment scenarios, but in reality we don’t know exactly what will happen. As much as I hate to admit it, we are often times just guessing.
That’s why your personal finances need a monitoring system–a way of checking the indicators of your ongoing financial wellbeing, as well as a set of rules to implement when results do not match expectations. You might think of it as your retirement dashboard. Just because everything is in good working order when you begin your journey, it doesn’t mean you can ignore the gauges and warning lights along the way.
To help you navigate the many factors and unknowns, I have developed The Three Strategies of Prudent Retirement Management. This comprehensive system includes:
- A Retirement Income Strategy
- An Investment Strategy
- A Monitoring Strategy
Implementing my strategies will allow you to focus on your vision for retirement—the lifestyle you want today, goals for the future, and the option to leave a legacy.
You’re invited to learn more about these strategies. I would be happy to schedule an appointment with you to explain how my system can help you achieve your ideal retirement vision. Just call me at (714)771-6000 or send me an email to firstname.lastname@example.org. I look forward to talking with you!
Professor Rick Ulivi, Ph.D.
Ulivi Wealth Management