Remember those brain-twisting math problems from high school? “Two trains leave the station at different times. Train A is traveling at 60 miles an hour. …” You know how they go. But here’s one riddle our teachers never gave us: You retire at 65 years old with $500,000 in savings. How many years can you count on before running out of cash? Yikes! It’s enough to make you nostalgic for the carefree days of train math.
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Crunching those numbers has only gotten more difficult with our increasing life expectancies. The average American man can anticipate living nearly six more years in retirement than his counterpart 50 years ago; the average woman, nearly five more years. That’s fantastic news … assuming you have enough money tucked away. No wonder that a recent survey by research and consulting firm Cerulli Associates found that 58 percent of retirees and pre-retirees said running out of money was their biggest financial fear. To help you make sense of the New Retirement Math, we’ve found some tutors: financial advisers and academic researchers who’ve spent years studying how to safely manage retirement withdrawals. So before you take out your No. 2 pencil to tackle this equation, check out four retirement income strategies they’ve developed to maximize your spending while minimizing the risk of emptying your bank account.
Pete Ryan
The 4 percent rule
- In plain English: Withdraw 4 percent of savings the first year and increase annually with the inflation rate.
- The gist: During your first year of retirement, you can withdraw up to 4 percent from your retirement stash, be it IRAs, 401(k)s or other accounts. With each subsequent year, increase those withdrawals based on the rate of inflation. So if you have $500,000 in retirement savings, you’d withdraw $20,000 during your first year. The next year, if the inflation rate is 3 percent, you’d withdraw $20,000 plus 3 percent of $20,000 — or $600 — for a total of $20,600.
- Behind the strategy: Bill Bengen, a financial adviser and researcher, came up with the 4 percent rule in the early 1990s in an effort to determine how to make a simple retirement portfolio — one invested half in large-company U.S. stocks and half in government bonds — last over a 30-year period, even when markets were at their worst. He’s fine-tuned it over the years. By adjusting the balance to 55 percent stocks and 45 percent bonds and adding international and small-company stocks to the mix, he says, you can increase your initial withdrawal to 4.7 percent.
- Drawbacks: Old research yields old results. Bengen’s calculations were tested on past market performance, so an unprecedented or prolonged stock market downturn could throw off the math. And because the rule is designed expressly to withstand worst-case scenarios, you could end up with a lot of unspent (and unenjoyed) wealth in your later years if the markets stay healthy.
- Consider it if …: You want a simple calculation with risk low enough to help you sleep at night.
Pete Ryan
The guardrails approach
- In plain English: Treat yourself, but watch the markets and bring your pocket calculator.
- The gist: You start out with a first-year withdrawal of 5.3 percent, with 60 to 70 percent in stocks. Each subsequent year, you calculate a new annual withdrawal based on how much your portfolio has gone up or down and what the inflation rate is. As a result, your annual withdrawal may go up, stay the same or even get slashed.
- Hypothetical example: During your first year of retirement, you withdraw $26,500, which is 5.3 percent of your $500,000 retirement account. The next year, you adjust that initial amount for inflation. Often, that will be your new withdrawal amount; if the inflation rate is, say, 3 percent, your new number will be $27,300. But before proceeding, you compare that new number to your portfolio’s year-end value. Then, depending on whether it’s been a particularly good or bad year for your investments — that is, whether you’ve hit a “guardrail” preventing you from going too far off course — your second-year withdrawal could be very, very different. How different? In this example, it could drop to $24,600 (down about 7 percent from year one) or jump to $30,000 (up 13 percent).
- Behind the strategy: Jonathan Guyton, a financial planner at Cornerstone Wealth Advisors in Minneapolis who codeveloped this system, says he wanted to see how much more you could withdraw if you were willing to be more flexible. Guyton has been using this method with his own clients for more than a decade. “No one has had to significantly change their lifestyle or worry about whether their retirement income plan was a ticking time bomb,” he says.
- Drawbacks: So … much … math! And unlike acing your SATs, your hard work won’t always be rewarded. “There’s no free lunch,” Guyton says. “When one of the adjustments gets triggered, you have to take your medicine.” To prepare for the years when you get a retirement pay cut, Guyton suggests setting aside a little extra money.
- Consider it if …: You want to start with a larger payout but don’t mind doing the math (or working with a financial adviser).
