Written By: Steve Stravolo
The number one fear people have in retirement? Running out of money.
If this is your number one fear about retirement, then you may want to get a better idea of how this could happen to you. At a quick glance, the answer is very simple. If you are spending more money than you are bringing in over a certain period of time, then you could eventually run out of money.
Income can come from various sources during retirement such as Social Security, pensions, part-time work and rental income. People can also draw money from their IRAs and investment accounts as a source of income in retirement as well.
In an effort to make sure you never run out of money, how do you know if you are currently withdrawing too much from accounts?
Extensive research has been conducted in the financial services industry addressing the topic of withdrawal rates. “Withdrawal rate” is defined as the annual percentage of assets that is being taken out of a retiree’s accounts. A good general rule of thumb is that 4% to 4.5% is a good maximum target and should be sustainable over an average lifetime.
Let’s say that you and your wife are 65 years old, you are both retired and you have a total $500,000 of investments. The rule of thumb is that you should not draw more than 4% to 4.5% from these accounts per year. Therefore, $20,000 to $22,500 is the maximum amount that you should take out of your accounts per year.
There are many factors that need to be considered beyond the 4% to 4.5% maximum withdrawal rate. First, it is a good idea to know what average life expectancy is and consider your own health, and family history. You should also think about your lifestyle choices such as exercise, tobacco use, etc. Another important factor is the source of your withdrawals: is it an IRA where all your distributions are included on your tax return as taxable or is it a Roth IRA that is non-taxable (as long as you’ve held it for at least 5 years)? Or, is it a non-qualified savings account where distributions are not taxable?
You should also consider whether your other sources of retirement income like a pension will be adjusted upward over time for inflation.
Finally, your age at first withdrawal is an important factor. Let’s say that you fully retire at age 70. You might be able to withdrawal at a higher rate than someone who retired at age 60. A couple who is in their mid-to-late 80s may be able to withdrawal at a higher rate than 4% to 4.5% as well.
Given the wide range of factors affecting appropriate withdrawal rates, the best strategy is to run the numbers. Go through the formal process of creating a plan for retirement. By running the numbers using conservative assumptions, an appropriate withdrawal rate can be calculated.
Sometimes, a plan that has an average withdrawal of 4% in the first 10 years of retirement, may move to 5-7% in the next 10 years. In the last 10 years of someone’s life, maybe a withdrawal rate of 8-10% is appropriate.
In conclusion, the 4% to 4.5% rule is a guideline. The best strategy is to work with your advisor and go through the planning process. Share your needs, wants and wishes in as much detail as possible so that your advisor can truly understand your unique situation and get to know your plan inside and out. Learn how different assumptions and facts drive the numbers. There will be greater clarity about what is possible and more importantly, increased confidence as a result of the planning process. It is a powerful tool to help conquer the #1 retirement fear.
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