After spending 60+ years trying to GROW our nest eggs, we’re suddenly faced in retirement with SHRINKING them. This sudden about face can give us whiplash — and scare the heck out of us. In fact, one financial advisor told me his clients were more afraid of running out of money in retirement than they were afraid of dying(!)
So… regardless whether we have $50,000, $500,000, or $5 million — what is our number? Just how much can we withdraw from our funds/investments each year — and still feel confident we won’t run out?
Financial advisors typically cite one (or both) of these two withdrawal strategies — the 4% rule or the bucket strategy:
STRATEGY ONE: 4%/year withdrawal
Many retirement advisors quote the 4% rule — which is that you can safely withdraw 4% of your total savings/investment each year of retirement (plus the inflation rate of the previous year) and have enough to last 30 years.
This was developed by Bill Bengen in 1994. He assumed a portfolio evenly split between stocks and bonds, and he checked every 30 year period in history starting in 1926 — and found the money lasted at least 30 years. His rule worked even if your retirement period included the “Great Depression.” It also, in some time periods, lasted even longer. However, many things can complicate this “easy” rule.
Why 4% may be too much to withdraw:
- Taxes: If you withdraw 4% of your total funds from an IRA, 401(k), 403(b), or other tax-deferred account, you won’t have 4% after tax. If you want 4% net in your pocket, you’ll probably have to withdraw 5-6%, and that violates this principle.
- Low yields on safer investments: When bonds, money market funds, CDs and other low-risk investments are paying historically low rates, 4% may well be too high.
- Longevity: What if you live longer than 30 years? After all, an “average” expected age of 90 means one heck of a lot of people will live LONGER than that! You need to plan for your money to last as long as you might last! The Social Security Administration (who should know) tells us this:
- Women: A 65-year-old woman is, on average, going to live to 86.7
- Men: A 65-year-old man is, on average, going to live to 84.3
- 25% of 65-year-olds will live past 90
- 10% of 65-year-olds will live past 95
Why 4% may be too little to withdraw
- Many (historically) could have taken 4.5%: Most historical periods tracked by Bill Bengen would have allowed 4.5% and still covered you for 30 years. However… that doesn’t guarantee it will in the future.
- Your stocks/bonds allocations: Jane Bryant Quinn, in How to Make Your Money Last, adjusts the 4% rule depending on how much risk you’re assuming. Here are her recommendations for annual withdrawals (plus inflation):
- 3.5% if just 30% of your portfolio is in stock-owning index funds
- 4.5% if you have 40-60% in stock-owning index funds
- 5.5% — if you have 40-60% in stock-owning funds AND you cut your withdrawals way back in years when stocks drop
- Adjustment for withdrawals early in your retirement: Kiplinger says you may be able to withdraw 5 to 5-1/2% in the early years of retirement, as long as you know you will have to cut back in the later years. Many financial planners believe you should plan to withdraw more in your early years of retirement, less in your middle years, and more the last few years when you may need in-home paid helpers.
STRATEGY TWO: The “bucket method” of income withdrawal
The bucket method tries to give you the best of all worlds — safety and security for your money as well as a chance to profit from a stock market that is more likely to beat inflation.
In The Five Years Before You Retire, Emily Guy Birken says you need to split your portfolio into three buckets. The goal in this strategy is to never be forced to sell stocks when they are in the toilet and thus be forced to take losses that could rebound if given more time. The question is, what % of your current portfolio goes into each?
Years 1-5: This bucket is what you draw from in your first five years. Therefore it must be in the safest funds. For example, CDs, money market funds, and Treasury notes/bills.
Years 6-15: This bucket will support you through early middle years of retirement. As such, it should contain mostly bonds, but also safer stocks. The goal here is “safe growth” — hopefully beating inflation, but not as volatile as the more aggressive stocks.
Years 16 and beyond: Because you won’t be drawing from these funds for 16 years, it should be primarily stock index funds. You can have more aggressive stocks in this bucket. If the stock market dives in years 1-15, you won’t have to touch these funds. If the stock market rises dramatically, well… then you have a choice. You can leave the funds alone, hoping for more upside, or you could cash some of them out and put them into your Years 6-15 bucket.
Yes, people go broke trying to “time” the stock market. But… a fear with this strategy is that the stock market does fine until year 16 or 17 of your retirement, then nose dives(!) So if you see an all-time high in the market earlier, you might want to cash in some of those gains while letting the rest of it still ride.
Adjusting your “buckets”: The buckets method requires adjusting your buckets once a year. Thus after one year you switch some stocks to bonds and some bonds to CDs so that you always have 5 years worth of “safe” money, 10 years worth of mostly bond funds money, and the rest in stock index funds.
Before you decide
Check out SIPAs (single premium immediate annuities). You may find that you can get a higher payout by converting part of your portfolio into one or more of these. They won’t leave anything for your heirs, but if 4% of your total funds comes to $600/month and you could get $850/month from a SIPA — that could make a big difference in your lifestyle. To account for inflation, there are inflation-adjusted SIPAs, or you can buy one annuity in your late 60s, another in your early 70s and another in your late 70s. (You get a much higher payout rate the older you are when you buy.)
There are a lot of other annuity types than these two and I don’t recommend any of them. If you are attracted by a different type, make sure you get advice from a financial advisor who is NOT selling that type nor getting paid for people they get to buy them. (That means only trust a “fee only” advisor, not a “fee-based” or “commission-based” advisor.)
Marlene Jensen is a 71-year-old full-time marketing professor. Previously she was a VP at CBS and ABC and spent decades as an entrepreneur and pricing author/consultant. Sadly, none of these prepared her for the onslaught of marketers who now think her daily interests/needs consist solely of hearing aids, wheel chairs, adult diapers, medi-alert buttons, medications, and bath tubs you walk into.