A recently
published study from financial research house,
Morningstar, suggests traditional stock and bond investments won’t produce as
much retirement income as these have in the past. This means retirees will receive
less income from their investments or need to save more to fund their
retirement spending goals.
The authors of the study believe the investment markets may not
produce as high of returns in the future due to high market valuations and low
interest rates. If this is true, retirees may have to rely on less income from
these investments in the future, lowering their “safe withdrawal
rate.” The research is centered around a safe withdrawal rate. A safe
withdrawal rate is an answer to the question of how much someone can withdraw
from their portfolio each year, accounting for inflation, without running out
of money for at least 30 years. The study says the new safe withdrawal rate for
retirees today is 3.3%. For example, a 65- year-old couple retiring today with
a $1,000,000 account would only be able to support $33,000 of spending for the
first year. $33,000 is 3.3% of $1,000,000. Regardless of circumstances or
investment performance, the couple would increase their prior year spending by
inflation. If inflation was 3% in the first year of retirement, then spending for
year two would be $33,000 + 3% of $33,000 = $33,990. For many people, that’s sobering
news, most can’t afford to retire when they would like if they can only count on
3.3% from the starting balance of their investment portfolio. The important
point is that each financial situation is unique. There are several factors that
impact how much you can spend in retirement. Here’s 8 reasons why the 3.3%
figure may not apply to your situation:
1. Diversification. How you balance different types of
investments affects how much you can spend in retirement. Historically, having
a balance of stocks and bonds in your portfolio has resulted in the most
retirement income on average. Having too much invested in stocks (more than 70%
of your portfolio), or too little (less than 40%) usually resulted in lower
income on average throughout history.
2. History. Historically the worst
withdrawal rate for a portfolio of 50% US stocks and 50% US bonds over 30 years
has been 4%. The 3.3% figure is anticipating worse retirement
income than the Great Depression and the high-inflation, poor stock market
returns of the late 60’s/70’s. And remember, for 99% of the history that we have data
on, you could’ve spent more than 4%.
3. Spending Path. Most people don’t pull out the same amount of
income from their portfolios each year. Most withdraw more before income sources
kick in, such as Social Security and pensions, and decrease portfolio
withdrawals afterwards. The 3.3% figure assumes you will spend slightly more from
your portfolio each year, and never make any adjustments to your spending.
4. Income Flexibility. If you have some income flexibility
during retirement, you can safely spend more at the beginning knowing that you
can make some cuts if investment markets don’t deliver your anticipated return.
5. Historical Retiree Spending Patterns. Real
world data shows many retirees’ spending doesn’t keep up with inflation over
time. The safe withdrawal rate assumes your spending will match
inflation over time.
6. Outside income sources. If you have substantial Social
Security benefits, pensions/annuities, or home equity, you likely can afford to
begin at a higher staring withdrawal rate. The research doesn’t account for
outside income sources.
7. Inflation. The 3.3% figure assumes you will spend slightly
more each year, as you increase your income based on the amount of inflation.
If inflation is lower than the historical average, you can spend more. If
inflation is higher, you will need to spend less.
8. Taxes. The 3.3% figure is before taxes. While you may be able
to take 3.3% of the starting balance of your portfolio, you may owe taxes on
some of the funds. If you owe taxes, you can’t spend all of the money you
receive from your portfolio. Everyone’s tax situation is unique, so be sure to
account for the impact of taxes on your retirement income.
Before resigning yourself to working for a few more years to hit
your income goal, get advice from a specialist on what a realistic spending
figure could be for your unique situation.
