How low must retirement withdrawals go?
WASHINGTON (Reuters) - After a lifetime of diligently saving, retirees are faced with a new question: How much can they take out during retirement?
Retirement -- or the "withdrawal phase of life" as actuaries and other numbers wonks refer to it -- can present a psychological challenge. It's often hard to spend money that took decades to save.
But it's also a mathematical challenge. Spend too much, and you can find yourself running out around the time you hit 75 or 80. Spend too little and you can live a retirement life of ascetic self-denial, only to enrich your kids when you die.
For many years, experts have been helping retirees meet that challenge by telling them that 4 percent is a safe withdrawal rate. The theory, supported with lots of backtesting, holds that if you keep your portfolio diversified and start your retirement with a 4 percent withdrawal, you can increase your withdrawal by the inflation rate every year and be almost certain your money will last for 30 years. T. Rowe Price, for example, has suggested retirees can increase their withdrawals by 3 percent every year to cover inflation.
But events and developments of the last few years have cast some doubt on a 4 percent solution. In the first place, many people are retiring at 62 or under, and living into their 90s, so 30 years isn't always enough. Even more significantly, the market meltdown of 2008-2009 drove home the weakness of the 4 percent rule. When stocks and bonds deliver poor returns, even 4 percent isn't safe enough.
In fact, someone calculating their safe withdrawal rate in 2008 might only be able to take 1.5 percent of their money out, according to a paper from retirement expert Wade Pfau published in the Journal of Financial Planning. Pfau, an associate professor at the National Graduate Institute for Policy Studies in Tokyo, doesn't actually suggest that retirees restrict themselves to that degree. Rather he suggests that retirees amend their withdrawals by considering how their investments are doing and staying flexible.
"It would be a great pity if recent retirees scaled down their retirement expenditures and loved a more frugal lifestyle only to find at the end that a higher withdrawal rate could have been sustainable," he wrote.
Some financial firms have considered lowering their recommended withdrawal rate to 3 percent but have found it hard to gain traction. That's a safer rate, concedes T. Rowe Price spokeswoman Heather McDonold, but it may be "difficult and unrealistic for some folks."
For example, at the end of 2010, the average 401(k) balance held by a worker in his or her 60s, who had been on the job for between 20 and 30 years, was $159,654, according to the Employee Benefit Research Institute. Note that figure is probably high, because it only focuses on people with a long history on the job. A retiree who started pulling 3 percent a year out of that would be able to withdraw only $400 a month, enough for groceries perhaps but not much else.
Retirees who really want to get it right might back away from the math-intensive rule altogether. "The literature which suggests there is a significant number that is a constant of nature is very misleading," says James Poterba, professor of economics at the Massachusetts Institute of Technology and the current president of the prestigious National Bureau of Economic Research. "The safe withdrawal rate is very sensitive to the investment environment you are in."
So, how can you live well enough without risking your future? Here are some pointers.
-- Investments matter. William Bengen, a financial adviser and pioneer of the safe withdrawal rate methodology, found that retirees could typically bump their initial withdrawal to 4.5 percent of their accounts if they included small stocks (which typically grow faster than large stocks) in their investment mix. The typical 4 percent rule assumes an account holder retires with a mix of 60 percent stocks and 40 percent bonds. If all of your savings are in bank accounts earning less than 1 percent a year, your safe withdrawal rate will be lower than if you invest in a variety of stocks and bonds.
-- You don't have to increase for inflation every year. Most retirees living on their own money don't actually increase their withdrawals by 3 percent or some similar number every year. They try to stick with their initial withdrawal.
Your chosen withdrawal rate may not last forever, anyway. By the time you are 70 1/2, you're required to take minimum distributions from your tax-deferred retirement accounts. Because they are based on your life expectancy, those required withdrawals can end up higher than the 3 percent or 4 percent deemed "safe" when you are younger.
-- You can use common sense. Have a great year in the stock market? Maybe you can withdraw some extra money and take a special trip. If your assets have taken a hit, you might prefer to tighten your belt and spend less for a year or two. The same flexible approach that gets successful budgeters through their working lives should work in their retirement lives too.
-- If you own a house, you can front load some withdrawals. If you have a substantial amount of net worth tied up in home equity, you can take bigger withdrawals early, on the expectation that you'll sell your house or use a reverse mortgage to fund your later retirement years.
-- There are other reasons to front load. Taking more than 4 percent out of your account early on also makes sense if you expect to curtail your spending when you are older, suggests Christopher Van Slyke, a money manager in Austin, Texas. He has told some of his clients they can start with withdrawals as high as 6 percent, if they know they are going to cut down later on. That is a typical retirement spending pattern anyway, according to Labor Department data.
Perhaps the best reason to take bigger withdrawals early is to allow you to defer Social Security, say some retirement experts like Stephen Goss, the chief actuary of the Social Security Administration. Because your benefits go up by roughly 8 percent a year for every year until you start claiming them, using 401(k) money to live on between the ages of 62 and 66 or even 70 will enable you to boost those benefits to a significant degree. That's worthwhile, because Social Security benefits do last a lifetime and do adjust for inflation every year.
-- Don't go overboard. Early evidence is that the issue of safe withdrawal rates isn't worrying very many retirees at all. People between the ages of 60 and 69 who take regular withdrawals are actually pulling between 9 percent and 10 percent a year out of the 401(k) plans that T. Rowe Price manages, the company has reported. That's far too much, suggests McDonold, though she concedes that T. Rowe Price doesn't have any information about whether the people taking out that money have other pots of cash elsewhere.
(Editing by Jilian Mincer and Steve Orlofsky)
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