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Understand — and set — a safe retirement investment withdrawal rate

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Q: My wife and I have saved for retirement for nearly 30 years. We have a decent retirement account (with traditional and Roth IRAs, mutual funds, a limited number of individual stocks, 401(k) retirement plan and savings). The total is more than $700,000. I’m currently drawing full Social Security, and my wife starts at age 62 in four years. I have a retirement income from 30 years in the armed forces. I’m thinking of retirement within the next year or so. My question: When I start withdrawing from my investments and retirement funds, what is a decent burn rate? And what would be a decent rate of return for the funds with a conservative investment strategy given the current financial climate? I’m nine years older than my spouse and want her to live comfortably after I pass. Our ages are 67 and 58.

A: It’s good you have saved for 30 years because your “planning horizon” is at least 30 years. While you and your wife, alone, have life expectancies of about 82 or 83, the odds are that one of you will live longer, perhaps substantially longer. Even if your wife lives only to her expectancy of 83 years, that’s 25 years — and she has a 50 percent chance of living longer. Having such a long period to plan for makes all the studies of “portfolio survival” very important.

Using historical data, a portfolio that is 50 to 75 percent equities has a high probability of surviving the full period at a starting withdrawal rate of 4 to 4.5 percent, no higher. The dollars withdrawn are then expected to rise with inflation in each successive year. In other words, the studies assume that you will be spending as much money at age 95 as you plan to spend at age 60. Increase the initial withdrawal rate, and the portfolio failure rate rises rapidly. Most financial planners are reluctant to suggest withdrawal rates of more than 6 percent.

An increasing body of research indicates that a 4 to 4.5 percent withdrawal rate is too rich for our current financial markets, largely due to high stock valuations and low interest rates on fixed-income investments. Whether starting from current stock and bond yields or from more modest return expectations, the latest portfolio survival exercises show that withdrawal rates should be lowered to 3 to 3.5 percent.

As a practical matter, a rate that low simply won’t work for most people — even people such as you who have saved for 30 years. Fortunately, you have some major offsets that reduce the danger of running out of money. They may allow you to withdraw at the historical rate — that initial amount of 4 to 4.5 percent. Those offsets are:

(1) Because you have both Social Security and a military retirement income, you’ve got a strong “base” income. This means that much, perhaps most, of your standard of living is probably covered by guaranteed income rather than investment income. This gives you a bit more freedom to risk that the portfolio might not survive. Retirees with Social Security and investment income alone can’t afford such a risk.

(2) It is well documented that our spending declines as we get older and that our peak spending years are in our mid-50s. While everyone (quite reasonably) worries about rising medical expenses, consumer spending data shows that our other spending decreases a good deal more.

(3) While one of you may survive for 30 years, the reality is that one of you will be widowed for a significant part of that time. That’s sad, but it also means that the living expenses you plan for now will drop when one of you dies, reducing the need for withdrawals from the remaining principal.

(4) Financial planners want to be 95 percent certain that your money will last at least 30 years. In fact, the chance that either of you will be alive in 30 years is under 5 percent. I find this a good argument for erring on the side of spending a bit more now, while you are alive. After all, you have a much larger chance of being dead than you have of running out of money.

Other reports on this are at www.assetbuilder.com.

Correction

In a recent column, it was incorrectly stated that savings in a Roth IRA could not be accessed until age 59½ without penalty. This was correct for conversions from traditional IRAs to Roth IRAs. Roth IRAs that began as Roth IRAs are subject to different rules, with less money subject to penalty.


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