Retirement plan withdrawals

Skip,

Has someone stolen your identity? I can't believe a smart guy like you is asking this question.

Here is the famous study that siggests 4 or 5% withdrawal rates:

A 4% withdrawal rate means your portfolio should be 25X the annual income you need.

Tell me I miss understood your question, please.

Frank

HW Skip Weld> Someone recently mentioned a rule of thumb whereby if retirement plan

Thank you for making our job easier by trimming the referenced post and making succinct comments.

-HW "Skip" Weldon Columbia, SC

The 4% withdrawal rate as a rule of thumb has been discussed here over the past few months. 1/.04 = 25 so if one needs a starting withdrawal rate of say $40,000, then $1M results.

The number has been repeated enough, first the Trinity Study, the book, "The Number", and the Columnist Scott Burns who cites Trinity, among others.

I agree with Elle that "past performance is no guarantee..." and adjusting verb tenses here is probably a good idea. New readers would benefit from understanding that there are too many variables to be 100% certain of nearly anything.

The 4% is not cast in stone, I find it interesting that people would take shots at such a general guideline. But 2% is too low. And 6% (unless one is very old, or has short life expectancy) is risky. The 4% assumes that withdrawals increase with inflation. If one were to take the inflation increase only after an up year, the 4% can be adjusted upward slightly, or the risk of running out drops further. There's also some point, I don't know when, that spending drops. Maybe the vacations get cheaper and fewer on a plane. Fewer nights on the town. The 4% rule is more like the 15% rule that a new investor just starting work should try to save X% with a goal of X times final income. For some, the 15% is too little, for others, so much they can retire early. JOE

This inflation rule is another heuristic that makes little sense. If inflation is 3% annually, it says that the most spending ought to adjust to the amount of capital is 3%, and that the entire adjustment should occur in the region around zero portfolio returns -- one would expect that spending as a function of capital be a continuous and differentiable function, in mathematical terms.

If one is going to use a rule of thumb, spending each year a fixed or gradually increasing (to account for lower life expectancy as one ages) proportion of one's current capital makes more sense -- this automatically adjusts spending levels to portfolio performance.

Skip, First, thanks for all your hard work and contributions to this site.

As for your post: Like many have stated, the rule of thumb is of course oversimplified (that's why it is a rule of thumb), but it is not a bad starting point.

We often project 5% for our clients, because it is widely known that CPI based inflation measures are mildly overstated. We have recently encountered one problem, however, that everyone should keep in mind.

As clients age certain expenditures become more prevalent in their lives while others become less so. One of the primary expenditures that increase is healthcare. Unfortunately, healthcare has been inflating at a rate much higher than the average rate. If your client begins spending more on high inflation consumables and decreases many low inflation expenditures, you could find yourself in trouble using the 4% rule.

Thanks again

In another instance of my being a bit dense, I'm not understanding your first statement. If I read that correctly, you suggest that one's spending would rise/fall based on their portfolio value. In the late

90's spending shooting up, and then diving in 2001-3. A level headed approach is to enter retirement with an idea of one's budget and stick to it, making the changes needed (such as skipping a vacation in a really bad year) over time, but having some baseline.

Why do you object to increasing withdrawals, adding an inflation factor? But it's ok to increase based on age?

I guess spending based on performance can work for some, and if the tinkering is minor, can help the portfolio survive longer, but I believe this topic has been researched extensively, and the suggestion is not to "spend 4% of year end balance each year" but rather, "start with 4% withdrawal in year 1, and add inflation factor to withdrawal. Year 1 $40,000, year 2, $41,200 (if inf is 3%) etc.

JOE

But this works only if one has a large amount of discretionary spending.

-- Doug

Hi Doug,

Maybe we should remind the readers of this article you pointed out to me:

Here is a legitimite, if risky, analysis that justifies 7.6% for an agressive investor.

Frank

Douglas Johns>

(1) Choose a portfolio with volatility low enough that proportional withdrawal is not too painful.

(2) Use an immediate annuity and Social Security to create a base level of income that is livable, so that money invested in risky assets is devoted to discretionary spending.

(3) Make withdrawals proportional not to the portfolio value on Jan 1 but on the AVERAGE portfolio on Jan 1 over the last N (say 5) years. This would damp spending increases in a bull market and decreases in a bear market. But if one's portfolio craters and does not recover even after several years, I think one must face reality and cut spending to levels below what was anticipated, and/or increase income by returning to work.

A computer simulation could shed light on how well these strategies work.

The article cited is interesting, but I think that providing a number like 7.6% with no context does more harm than good.

You are not being dense -- we just don't agree :).

Because the strategy has you spending at the same rate until your capital drops to zero. Then what? Realistically, people DO consume less when they become much poorer, and they make adjustments before reaching bankruptcy.

It makes sense to increase the proportion withdrawn with age if one does not desire to leave a bequest and one would enjoy the extra consumption. In general, would a 60-year-old and 80-year-old be advised to spend at the same rate if they both have $1 million?

I think the financial services industry has been coming up with some really anal numbers to scare people into buying more of their products. Your stochastic extrapolator has to use time histories from before 1940 to justify below

5% (some use the entire 20th century) and 6% is not out of the question. One unamed brokerage whom I will call "M" suggests 3.5%. If you convince ma & pa to do that then you'll have a very nice inheritance. At the other end I know several people who stopped working in the late 1990s hoping to trade their to 10% and higher market returns for the rest of their lives, which was also crazy.

I'm personally using 6% plus a "reserve" (which is equivalent to a little below 5%). Look for my usenet posts in the future "will XXXX for food" when I fail :-)

One would hope so. However, I know enough people who are completely oblivious about money that I sometimes wonder.

No, but...

People sometimes live to 100. My grandmother made it to 99. Although there might reasonably be a difference in spending between a 20-year and a 40-year horizon, I'm not sure it's really that great.

And beware of upside risks. Someone might live to 120. And once they do what will health care be capable of in 2047?

Of course, if health care is really good, perhaps going back to work at

120 won't be a big deal....

When the horizon is that long all bets are off. Not only are changes coming, they are coming more frequently than in the past. Most present investments could turn out to be like investments in buggy whips just before the advent of automobiles.

Now this is an interesting idea...

-Will

What you said about 4% works if you average a 9% total return.

I've never heard of any Rule of 15 or 18, and I've heard everything, so you must have drempt it.

--Mike...

HW Skip Weld> Someone recently mentioned a rule of thumb whereby if retirement plan

In today's (1/17/2006) "Getting Going" column in the Wall Street Journal, Jonathan Clements, a personal finance writer, recommends the gradually increasing proportion method above, possibly supplemented with a reverse mortgage and/or immediate annuity at age 85. Ideally there would be software to simulate such strategies and make more precise recommendations.