Dear S&B: As I head into retirement, any rules of thumb when it comes to how much I can take from savings each year? Susan – Santa Barbara
Historically speaking, the number seems to be around 4%-5% with your distributions adjusted for inflation. For example, if you need $40,000 in the first year of retirement, the next we plan on taking $40,000 + inflation. Please see the Exhibit: Distribution Rates for us to discuss further.
We went back in history and assumed that retirement took place in 1970. We started with $1,000,000 and invested it 50% in stocks and 50% in bonds. Then we ran withdrawal scenarios from 4% to 9%. Forty years later, only the 4% withdrawal rate had money as all the others failed.
For a little additional perspective, from 1970 through 2011, the US Bond index had a return of slightly over 8% with the S&P500 a little under 10% and inflation as measured by CPI came in at 4.42%. If the market returns were higher than all but one of the distribution rates (4,5,6,7,8%), how can failure occur?
In years when negative returns occur and you pull money from the portfolio, you have less money to make the “comeback” and thus require an even larger investment return. For example, if you lose 20% in your portfolio, you need it to rise 25% to get back to even. If you pull out an additional 7% during that downturn and thus lose 27%, you need a 37% return to get back to even.
Additionally, while returns in the chart are not static, the distributions continue. Thus, if a portfolio loses money and you pull out the same amount as before, your distribution becomes a much higher percentage. A $40,000 distribution on $1million is 4% but if you pull out the same $40k on an $800k portfolio after a dip that is now a 5% distribution. Here are some planning items to consider.
Investment Management: As you head into the “distribution” phase of life, mentally prepare that your net worth will not increase like it had in the past unless you have “over saved.” As evident in the exhibit, most people struggle in retirement if they start out spending too much and thus cut into principal too early.
Consider focusing on income strategies as the primary objective with growth secondary as you head into retirement. If you can satisfy your lifestyle via the known income (dividends, rental income, pensions, social security, interest, etc.) then you are in a great place to ride out market downturns as you can “wait.”
If you rely heavily or demand steady market returns in order to satisfy your lifestyle, that is a stressful place to be where the statistics are very much against you. Risk Management: In your planning, make sure you set aside mentally or literally about $250,000 for potential long term care costs. You can either segregate money in your accounts or reallocate funds toward insurance to cover this what if.
Wealth Management: When it comes to planning and you think you may run out of money in the future, there are four major items to consider; life expectancy, expenses, inflation and investment return assumptions. Life expectancy according to the government is around age 82. We know historical rates of return and inflation statistics but the future is unknown. So focus on the areas you can control, spending, saving and your investment allocation.
If you have any questions you want addressed, please submit them to email@example.com.
Author’s Note: Brad Stark, MS, CFP, AAMS, CMFC and Seth Streeter, MS, CFP are Co-Founders of Mission Wealth Management, LLC, a Registered Investment Advisor. The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action. Securities offered through National Planning Corporation, Member FINRA/SIPC. NPC and MWM are separate and unrelated entities. Certain statements contained within may be forward-looking statements, including but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties; all statements are subject to change without notice. Dividends are subject to change and are not guaranteed. Also, historical performance cannot predict future results. Investing directly in an index is not possible. You should not base specific investment actions on any information contained within. Speak to your advisors before investing. The above exhibit is used as an illustration only, not indicative of any particular investment; actual results will vary. It assumes reinvestment of dividends with no consequence of fees or taxes. Investment decisions should e based on an individual’s goals, time horizon, and tolerance for risk.