Among the biggest challenges that an individual will face in their lifetime is the transition from working to earn a living, to sustaining that same standard of life through retirement. For years we’ve become accustomed to saving money in preparation for retirement, which — independent of other variables — is great. However, the psychological reversal of a save first/spend later mentality is a difficult process, to say the least.
This is due to the fact that many retirees lack a clear plan on how much they can (or should) comfortably spend in retirement.
Because it’s much easier to focus on squirreling away money during your earning years, than to consider how you’ll spend it when your income options are limited.
It’s probably a result of the ‘save-for-a-rainy-day’ philosophy that we’ve all been indoctrinated with most of our lives.
But just because you’ve been a good steward of your money, doesn’t mean you won’t run the risk of withdrawing more than you should from your nest egg.
The reality is, no one wants to outlive their money; but it’s easy to do if you don’t have a plan. Since it’s our goal to make sure that your money lasts through your lifetime and beyond, we’ve decided to tackle one of the toughest questions that you’re bound to face in your financial life: how to determine what you can safely spend in retirement.
In contrast to the wages received via traditional employment, retirees have many sources of income to rely upon. Here’s a quick look at some of the most common.
Social Security: Based on 2016 numbers, nearly 60 million Americans receive some form of benefits from the Social Security administration. Of that number, nearly all retirees (~84%) receive Social Security payments — with 52% of them receiving at least half of their income from Social Security.
With statistics like that, it’s safe to say that Social Security plays a large role in the amount of income that you will receive in retirement. But perhaps what’s more important to note is the fact that when you sign up for Social Security directly affects the amount that you will receive each month.
For example, if you sign up for benefits before the full retirement age (66), you will receive a reduced monthly payout. Alternatively, if you delay your start date until the age of 70 your monthly check could increase substantially.
Put simply, if you are relatively healthy and have other sources of income to manage your monthly expenses, you stand to get a better bang for your buck by delaying Social Security a few years out.
Employer-Sponsored Retirement Plans: Employer-sponsored plans like 401(k)s, 403(b)s, and SIMPLEs are useful tools that provide benefits to both the employee and employers. According to a report conducted by the Social Security Administration, employer-sponsored benefit plans provide income to 44% of retirees, and account for 21% of the total income for people over the age of 65.
For many retirees, these plans are used to supplement income and provide more financial flexibility than retirement with only Social Security income would provide. The key to making these funds last is to gradually draw down your balance in a way that ensures it will last throughout your lifetime (typically at a withdrawal rate between 3-5%).
Post-retirement Employment: These days more retirees are finding financial security, not in the monthly checks from an old pension plan or Social Security, but rather income from post-retirement employment. This has become so common that the percentage of all retirement income coming from post-retirement employment has steadily increased to over 32% in 2014.
Not surprisingly, these numbers are driven primarily by young retirees — with nearly 49% of people between ages 65 – 69 receiving at least a portion of their income from earnings, 31% among people in their early 70s and 19% in their late 70s.
For many years, the topic of “safe withdrawal rates” has been the subject of intense debate within the financial services industry. Among those that have left a lasting mark with their work on the subject is William Bengen — the publisher of a study that popularized the idea that taking 4% of your asset value in the first year was a safe percentage to use.
Bengen built his study around the premise that the average person, invested in a diversified portfolio of stocks and bonds, would retire around the age of 65 and need their money to last through age 95. By taking into consideration different rolling investment periods, he wanted to determine at what withdrawal rate and how often people ran out of money before the conclusion of the 30-year period.
Over the years, several variations of Bengen’s theory have cropped up; some of which argue that you can start with an initial withdrawal rate as high as 5.9% and not lower your chances of success (read: not running out of money) if you can be flexible with annual inflation increases. Alternatively, if you must have inflation increases every year, then 4% is probably an ideal starting point.
All considered, you can assume an initial withdrawal rate of anywhere from 4% to 6% depending on where you stand regarding inflation increases (and if you’re willing to forego inflation increases in bad years).
While it’s absolutely possible to figure all of this out on your own, even Mr. Bengen advises that you seek a qualified advisor to help you through the process. In his words, “You are planning for a long period of time. If you make an error early in the process, you may not recover.”
And we couldn’t agree more!
Rather than go it alone, why not seek the objective counsel of a financial planning firm that has over 20 years experience helping clients make sense of this and many other finance related questions? It’s time you take control of your financial future. Click here to schedule a meeting to discuss your financial situation and see if Fox Financial is a good fit.