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Sustaining Lifetime Income Throughout Retirement

February 19, 2013

(Reprinted from the March 2013 edition of Bath Country Journal and Richfield Times.)

An estimated 10,000 people are retiring every day, and this unprecedented surge of new retirees is expected to last for the next 17 years.  Most will roll their retirement plan assets into an IRA account, and that money plus Social Security and any additional savings and investments they may have will provide their living expenses for the rest of their lives.

This is different from retirees in the past, who often received regular payments from their defined benefit pension plans—their equivalent of a retirement paycheck.  New retirees are being required to make a new kind of calculation: how do I translate a lump sum of money into sustainable income over the rest of my life?  After becoming accustomed to receiving a paycheck perhaps for forty or more years like clockwork, this transition is not an easy one to make financially or emotionally, regardless of the size of your asset base.

Suppose, for example, a 65-year-old couple retires, and they have a total of $3 million.  They can start receiving $3,750 a month combined from Social Security.  With so much money in the bank, they feel comfortable joining an expensive country club, providing ongoing support to their children, and before long, a large recreational vehicle is parked in their driveway.  They now buy a lot in a motor coach resort in Naples and remodel the kitchen and bathrooms in their Ohio home.  By age 68, they still have $2 million in the bank and back down to spending $12,000 a month.  Are they all right, or not?

This is the kind of calculation that financial planners who serve retiree couples wrestle with all day long, and there are few definitive answers.  Some of the pioneering research into safe spending in retirement, most notably by Bill Bengen, takes into account what is called "sequence risk"--meaning that some unlucky retirees will experience a severe market drop in their early years, which will make it more likely that they'll run out of money before they die.  The research assumes that the retired couple wants to raise spending, each year, at exactly the inflation rate, so they maintain spending power.  Then it looks at the historical market returns, and identifies a spending level that would have survived even the worst sequence-risk scenarios.  The answer is between 4% and 4.5% of the retirement portfolio in the first year, with that dollar amount rising with the inflation rate each year.

In our hypothetical retiree example, Social Security is paying for $45,000 of the couple's living expenses, meaning the portfolio has to come up with an additional $99,000, indexed to inflation, for the next 30 or so years.  That comes to about 5% of the remaining portfolio.  The couple feels financially solvent, but they may be at risk if the market turns down in the next few years or substantial and unexpected expenses materialize such as those for a long-term healthcare need.

Of course, all of this research focuses on surviving the worst-case scenario—the times when the markets are least favorable to a comfortable retirement.  If the market climate is instead sunny during the early years of retirement, then their current spending will not be a problem, and they may actually be able to increase their lifestyle expenditures.

More recent research by Michael Kitces shows that safe withdrawal rates of 5.5% can be sustained when market valuations, as defined by price to earnings ratios, are at historical lows—think early 2009. With today’s valuations, Kitces shows a rate of 5% can be sustained. Yet, a paper published in January 2013 by retirement researchers Michael Finke, Wade Pfau, and David Blanchett, entitled "The 4 Percent Rule is Not Safe in a Low-Yield World" concludes that in today's low interest rate environment the risk of failure for a 4% safe withdrawal rate may be upwards of 50% if rates stay this low indefinitely but failure remains at 18% even if rates normalize to long-term trends in just five years.

Sounds Like a PlanEven though this research is very useful in retirement distribution planning, it says nothing of how a retiree’s spending may change as they age or what failure actually means. Does failure mean that not only do you have to stop supporting your children but also move in with them? Or does it mean you had to sell your luxury motor coach and lot a few years before you would have liked? These are obviously markedly different degrees of change.

The best way to stay in the safety zone of retirement planning is to in fact have a plan and to have a professional run the numbers at least every year in light of recent market activity and long-term guidelines. Converting a portfolio into a paycheck is a surprisingly complex exercise and investment planning and tax planning also need to be considered holistically in conjunction with creating your lifetime paycheck.  Ten years down the road, when a few million baby boomers are well into retirement, you may be reading about some of the simple, innocent, yet tragic mistakes they made with their spending decisions when it felt as if they were flush with cash.


Kevin Kroskey, CFP®, MBA is President of True Wealth Design, an independent investment advisory and financial planning firm that assists individuals and businesses with their overall wealth management, including retirement planning, tax planning and investment management needs.

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