Keeping the gold in the golden years
Congratulations if you've saved enough money for a comfortable retirement. Now comes the hard part: spending it.
With more people living into their 80s and even 90s, having enough money to last literally a lifetime is a major concern. Your working years were consumed with how much you could make. Retirement planning is about how much you can take without running dry, and which accounts -- taxable or tax-deferred -- to tap first.
Many retirees force themselves to spend less. Or they shift more money into bonds, dividend-paying stocks and other conservative, interest-bearing investments, intending to use the regular income for expenses and not dip into principal.
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That seems prudent, but such penny-pinching strategies will likely lead to disappointment in both the quality of your life and the quantity of your savings, financial planners say.
"People need cash flow; they need money and they need it to grow by more than the inflation rate," said Harold Evensky, a financial adviser in Coral Gables, Fla. "You need to think holistically and throw out the concept of an income portfolio."
Few seniors have amassed enough assets to meet income needs from bonds and dividends alone. Plus, over time yields fluctuate and inflation weakens a portfolio's purchasing power.
In response, financial planners increasingly advocate a retirement-spending strategy that hinges on withdrawing a set percentage of a portfolio's total asset value in regular installments. Think of it as salary you pay yourself.
The '4% solution'
A generalized approach to spending starts with a "4% solution" -- taking 4% of a portfolio's total value in the first year of retirement and increasing this amount annually to match inflation. For example, withdrawing 4% from a $250,000 portfolio would generate $10,000, or $833 a month. If inflation was 3%, you'd pocket $10,300 the next year.
But 4% is a baseline. A study by financial adviser Jonathan Guyton, published in the March 2006 Journal of Financial Planning, says retirees can accelerate spending provided they adjust to market fluctuations.
His research shows that retirees can confidently withdraw as much as 5.5% each year for 30 years, adding an amount equal to the rate of inflation, from a portfolio of 65% stocks, 25% bonds and 10% cash. A mix of 80% stocks, 10% bonds and 10% cash could support a 6% payout each year. That's riskier, to be sure, but still carries an equally high probability that your money will last.
No matter your portfolio allocation, a successful outcome depends on sticking to certain guidelines, Guyton says.
First: If the value of your portfolio after you have withdrawn your money is lower at the end of the year than when you started, you do not make any adjustment for inflation in the following year's withdrawal.
In rarer cases, gains or losses may be large enough to hit what Guyton dubs "guardrails."
In periods when losses are severe enough that the portfolio withdrawal rate increases by a percentage point or more, say to 6.5% from 5.5%, you employ the "capital preservation" guardrail: Take the inflation adjustment for the following year, but reduce the total amount to be withdrawn by 10%. In this example, a $10,000 withdrawal with 3% inflation would equate to $10,300 less 10%, or $9,270.
On the other side of the lane is the guardrail for better conditions. If the percentage of your total assets withdrawn decreases by a percentage point or more, take the inflation adjustment for the following year and give yourself a 10% increase. So if you would have withdrawn $10,300, you can comfortably award yourself an extra $1,030.
"With these guardrails, you can navigate the tough times," Guyton said. "If you have a big enough gain, trip the prosperity guard rail and get the bonus."
Money matters
When drawing down assets, planning experts say to keep in mind other important rules of the retirement road.
Rebalance the portfolio: To fund portfolio withdrawals, bring stock-bond allocations back to preset levels once a year. Sell long-term stock-market winners first, paying the 15% capital-gains tax (5% for filers in the lowest bracket), Guyton advises. If that doesn't cover your needs, then sell bonds and cash. Only in a pinch do you part with underperforming stocks, he adds, giving laggards time to rebound. For the same reason, turn to bonds and cash first in years where the portfolio posts losses.
Sell securities from taxable accounts first: This way, your money in 401(k), IRAs and other qualified plans continues to grow tax-deferred. "By taking the money out of the more heavily taxed account first, your portfolio may last another few years," said Bill Reichenstein, professor of investments at Baylor University.
An exception: Those with unusually low taxable income in years leading up to required minimum distributions after age 70 1/2 should take advantage by either withdrawing money from a tax-deferred account or converting money from a traditional IRA into a Roth IRA , Reichenstein adds.
Spend more early in retirement: It's probably OK to boost the withdrawal rate when you're more active and cut back in later years. But do so only if health care and other costly expenses are covered.
Gear retirement spending to expected cash flow: Bill Bengen, a California-based financial adviser who coined the "4% Solution" in an influential 1994 Journal of Financial Planning study, is crafting another portfolio innovation: basing withdrawal rates on a client's total financial circumstances. Will you rely on a fixed pension plan that doesn't keep pace with inflation? Probably you can't spend as much. Are you banking on an inheritance or about to pay off a mortgage? Maybe you can spend more.
"Using a year-by-year forecast, you build a model of retirement going out to the end of lives," Bengen said. "It's nice to come up with a number like 4.5%, but what does it mean if you're not looking at the rest of the client's situation?"
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