Many factors could have a significant influence on your retirement, from unforeseen expenses, such as high costs of caregiving or medical in your area, to drastic declines in the stock market. If you don’t use your retirement savings and investments, you are certainly guaranteed a lower lifestyle standard, than what you could achieve otherwise. Not spending, or spending too little, aren’t traits of safe withdrawals.
Unfortunately, not many retirees have identified a sturdy spend-down strategy that would allow them to enjoy their retirement without outliving their hard-earned assets.
According to J.P. Morgan Asset Management and the Employee Benefit Research Institute, nearly 80% of retirees do not begin withdrawing money from their accounts until required minimum distributions (RMD) begin. Additionally, of those at RMD age, 84% took no more than the minimum quantity.
Basically, retirees allow RMDs to dictate how much they can take out of their retirement accounts, which could be a great mistake.
RMDs are the amounts that the government requires you to withdraw each year from your traditional retirement accounts, after reaching the age of 72. Each person’s RMD is calculated by dividing your retirement accounts’ balances from the previous December 31, by your life expectancy.
Given that most people retire in their 60s, age 72 is a long stretch of time to wait before using an important source of retirement income. Furthermore, only withdrawing the minimum amount from your accounts, could mean that you pass away with a significant portion of your assets remaining.
If you wouldn’t want someone else to enjoy the funds you worked hard for, what then is a safe rate of withdrawal that would allow you to live the retirement you want?
Outliving your accounts vs. Being outlived by your accounts
The rate at which you withdraw from your accounts certainly influences your portfolio’s longevity. The chart below displays the longevity of a $500,000 portfolio composed equally of stocks and bonds, over a 20-year period, spanning from 2000 to 2020.
It is not clear that a low withdrawal rate will produce long portfolio longevity, and vice versa. The example portfolio with a withdrawal rate below 4% even grew beyond the starting balance. While this may sound attractive, there are potentially significant drawbacks to an overly conservative withdrawal rate. This is the opportunity cost of not using any of that money to enjoy your retirement, even though you had the ability to.
Retirement was never meant to be a time to accumulate your assets. It’s meant to be a time to spend down assets so that you can achieve your long-term financial goals - the vacation home along the beach, the vacations you always wanted, etc.
That doesn't necessarily mean that all retirees should start thinking about how to spend more either. Instead, this highlights the fact that a plan to utilize your assets is just as important as one to grow and accumulate them. Balance and flexibility must be practiced as retirement is approached and lived through.
Withdrawing safely, while maintaining the lifestyle you want
There is plenty of uncertainty surrounding retirement. Important variables include your health, financial market performance, your interests, anything that could change at a given time.
The best way to adapt to personal and market changes through retirement is to be flexible with your withdrawal rate. Consider this the power to rewrite the story of your retirement as your life, and financial settings go through changes. At the end of the day, a safe withdrawal rate is a flexible withdrawal rate.
Simply explained, you are to allow yourself to withdraw a little more in some years, and a little less in other years. In a given year, you might increase your withdrawal rate to fund home renovations or a family vacation. Then, you may reduce your withdrawals during a market downturn, as long as you cover your necessary expenses).
Of course, the portion of your savings that can be sustainably spent each year through retirement is influenced by many personal factors, such as your annual expenses, amount of wealth, age, market conditions, retirement age, sources of guaranteed income (social security, pensions), etc.