How Long Will My Money Last? New Retirees Face Double Whammy
Category: Financial and taxes in retirement
August 17, 2022 – After reaching record highs, the stock market is down almost 12% this year. Perhaps just as bad, inflation is raging at over 8%. Both of these developments make for a terrible situation for retirees, especially for those just beginning their retirement and worried about outliving their money.
It is far easier to predict how long your savings will last in a stable environment with low inflation and friendly stock and bond markets. Unfortunately, that is definitely not the case now. Our hope is that the tips and suggestions in this article might help people better negotiate these tricky times.
Tried and true – the 4% rule
Although there are many theories on how to take distributions from your retirement portfolio, the most enduring is the 4% rule. Most experts agree you probably won’t outlive those savings if you take that much out each year (and some say 5% is also a safe number). But these are only general rules, and unusual circumstances like we are having now can upend them.
For younger workers, a downturn like we are having now doesn’t have much of an effect, as they have a longer time frame for things to even out. But for someone just entering retirement, this can be a serious problem, as they need money now.
As an example of what can go wrong, let’s say you had retirement savings of $250,000 the year before you retire. You plan to take out 4% the first year of your retirement, which will add $10,000 to your Social Security and any other retirement income. But if those savings declined by 6% by the time you start retirement, you will actually only have $235,000. Taking 4% of that would only yield $9,400. Making that worse is that with 8 or 9% inflation, that $9,400 is only worth $8,648.
After that distribution the value of those savings, if the market did not go up or down, would be worth $225,600. That would lead to a 4% distribution of $9,024 (before inflation) in the following year, beginning a vicious, downward spiral for the rest of your retirement.
A recent NY Times article, “The Tricky Math of Retiring into a Downturn“, outlined some options to the 4% rule that might be able to help in this situation.
Reframing. The TImes article suggested that retirees who face a down market and high inflation should consider what they really need, as opposed to what they would like to have. That might suggest only taking out enough to fund real needs, and postponing a big trip or major purchase. That strategy would be a way to preserve capital and wait for markets to recover.
Keep a cash bucket. This is harder to do but can be very useful if you can swing it. If you have enough to fund a year’s worth of expenses not covered by your Social Security or pension, using it now could avoid having to invade your savings in a down market.
Be flexible. Up and down markets can affect how much you can safely take out of your savings. If the inflation adjusted value of your retirement investments drops below what it was when you first retired, taking out 4% will result in a withdrawal amount higher than what you originally calculated. In this case, it might be a good year to take out less than 4%. On the other hand, if the market surges and your investments are worth more than expected, then you can probably afford to take out a higher percentage. If the market drops after that, the loss won’t feel so bad because you got to enjoy the money. One rule of thumb suggested by experts is to divide your retirement savings by the number of retirement years you need to fund. That calculation is how much you can probably safely take out each year. As an example: if you have $250,000, are now 70, and hope to live to 95, then you can take out $10,000 per year ($250,000 divided by 25 years).
Tricky times
One of most retirees’ greatest fears is outliving their money. The double whammy of high inflation and a declining stock market increase the risk of that happening, particularly for someone just starting retirement. People need to be flexible in difficult times in order to be safe for the long term.
Comments? Do you think your savings will last long enough to fund your retirement? Have you faced a tanking stock market and high inflation before? What will be your strategies for coping?
Comments on "How Long Will My Money Last? New Retirees Face Double Whammy"
B. Lovison says:
I really liked this article as it assured me that I was on the right track regarding retirement $$ vs inflation and longevity. Thanks so much!
Jerry O says:
"One rule of thumb suggested by experts is to divide the number of retirement years you need to fund by 25". I expect 25 retirement years, so 25 divided by 25 = 1. Now what do I do with the result? (the number 1)?
Editor's comment: Thanks very much for that correction Jerry. We bollixed that sentence up, and have corrected to read: "One rule of thumb suggested by experts is to divide your retirement savings by the number of retirement years you need to fund. That calculation is how much you can probably safely take out each year. As an example: if you have $250,000, are now 70, and hope to live to 95, then you can take out $10,000 per year ($250,000 divided by 25 years)." Thanks!
Louise says:
Can you get into more details on keeping a cash bucket? I really can't grasp what that is trying to say.
Can you give examples?
JCarol says:
Hi Louise,
There is an investment approach that uses a "bucket" strategy. It just means splitting your assets or income streams into
1) Fairly immediate needs (1-2 years is usually considered short term)
2) Longer term needs (2-10 years out)
3) Very long term (10 years and longer)
The short term or cash bucket typically includes funds you can get your hands on quickly without paying big penalties or worrying about potentially locking in losses (if the stock market is down, for instance). So you'd want cash bucket funds in CDs, savings accounts, and so forth.
Hope that helps.
John Brady says:
I think JCarol's explanation is right on the money. Not everyone is in a position to have a cash bucket, but if you can swing it is a wonderful thing. Consider it as money you have put aside and are not really counting it as part of your retirement savings, it is an emergency fund. So it should be pretty liquid, like in a money market fund or a very conservative mutual fund, so you can get the money out quickly and not have to worry about it being an investment that is down at that time. Using it to fund your lifestyle in a down market might help preserve your capital and give the market time to recover.
Dave Levin says:
I think this article did not explain the 4% rule properly. The idea is to take 4% of your saving the first year, and then adjust that amount each year based on inflation. You do NOT just take out 4% each year.
Also, the concept of dividing your savings by 25 is just another way to calculate the 4% rule...it has nothing to do with the number of years you plan to be retired.
John Brady says:
Good points Dave. Yes, the 4% rule of thumb isn't quite set it and forget it. Two things are going on that could upset it - what is happening to your portfolio, and the inflation rate. If whatever you are invested in goes up a lot, your 4% will give you more money. But if inflation is also going up by the same amount the effect could be neutral. The worst things that can happen are that the value of your savings declines and inflation goes up. If you keep taking 4% out of a smaller and smaller number that buys less and less, that could be trouble in your old age. Similarly, if you take out more than 4% to make up for inflation but your portfolio doesn't go up by that much, it could be trouble. The point is, keep readjusting to make sure your money lasts as long as you do.
My 25 years was not a good example. I think the point is to divide your portfolio by how many years you want it to last. 25 years to go gives you 4%, but if you are 80 and expect to live to 90, then 10 years gives you a 10% withdrawal rate.
One other method not mentioned here is to use the IRS formula for required Required Minimum Distributions (RMDs). It starts at 3.66% for someone 72 years old (it would be lower if you are younger). Then it increases every year as your life expectancy declines, so by the time you are 85 it is 6.25%. Personally, I think that is a pretty good way to look at it.
Mike says:
A recent interview with Bill Bengen,the man who's research resulted in the 4% withdrawal rate. https://www.thinkadvisor.com/2022/05/09/bill-bengen-revises-4-rule-says-to-cut-stock-and-bond-holdings/
Mike says:
An article about using RMDs instead of the 4% withdrawal rate:
https://www.thinkadvisor.com/2022/02/09/do-rmds-work-better-than-the-4-rule/
Larry says:
All good points and I am glad John clarified that the 25 years is just an estimate of retirement length. Some folks have pre-existing medical conditions that might cause them, despite the improvement in drugs and medical care year to year, to set a less aggressive timeline...In 2008, when the markets crashed, I was assisting people in finding homes in golf communities in the South. When Lehman Brothers collapsed, many of them panicked and liquidated their stock holdings in their IRAs/401Ks and put the cash into "safe" accounts. Better, they reasoned, to get a 1/2% return than a negative return from falling equity prices. Unfortunately for them, it is typically a bad move to sell low because over time -- sometimes only a few years -- the stock market always rebounds (as it did significantly a few years later). So for that newly retired couple with a 25 year time horizon -- as some of my real estate clients had -- the panic reduced their financial portfolios permanently and meant that the retirement house they planned to buy in, say, 2012, after the real estate and stock markets began their recoveries, was now out of their price range. Sometimes patience is rewarded...One other point for those who have owned a home in the northern half of the country and want to retire to the South. You will find that homes in the Sunbelt are generally less expensive than in the North, especially if you are downsizing; and property taxes are dramatically lower than what you have been paying. In essence, when you find a home in a lower-tax area, you are giving yourself a raise and helping your money last as long as you do.
Mike says:
Another approach to the 4% rule:
https://www.advisorperspectives.com/articles/2022/10/24/the-4-rule-just-became-a-whole-lot-easier