What is the correct withdrawal rate for my retirement?
I’m going to answer a question that far too many retirees don’t know the answer to, ‘what is the correct withdrawal rate for my retirement?’
The question regarding withdrawal rates and retirement dates back decades. Since traditional retirement plans were brought about in the 1970s, people have sought to find out how much money they could withdraw from their retirement pot each year and still have enough to last until they passed away.
In the mid-1990s, it was assumed that based on life expectancy and current returns in the market, a retiree could take around 7% of their retirement pot per year and still be okay. But one individual began to question this logic. He was a native New Yorker born in 1947. He received a Bachelor of Science degree in Aeronautics and Astronautics from MIT. He worked for 17 years with his family-owned soft-drink-bottling franchise firm in the New York metropolitan area. The company sold in 1987, which is when he decided to become a financial advisor. His name is William Bengen.
Bengen started using what is called the Monte Carlo method to help determine the probable outcome of people’s retirement plans based upon certain withdrawal rates during the mid-1990s. The Monte Carlo method was brought about by Polish mathematician Stanislaw Ulam. He had been injured during World War II and, while laid up trying to recover, he played hundreds of games of solitaire. By playing these games, Ulam began to question whether he could use the power of the computer to help him determine probable successful outcomes of his solitaire game, and thus the Monte Carlo method was created. It is named after the gambling hotspot in Monaco, where Ulam’s uncle would go to gamble. But Bengen concluded from his calculations that the 7% withdrawal rate that was being recommended no longer worked and that, even at a 5.5% withdrawal rate, over 50% of the plans were failing. He finally settled on a 4% withdrawal rate and he called it the SAFEMAX rate.
But that was the mid-1990s and we’re now in 2020. Do the same withdrawal rates still work? Unfortunately, what we’re finding is that it doesn’t. Most financial advisors are now recommending a 3% withdrawal rate, but with interest rates being what they are, we’re finding that even this may be too high. The true rate may be as low as 2.5% based on longevity and current interest rates.
Let’s take a minute and think about this. If you can only take 3% in retirement each year, do you realize how much money you need to have to make it through retirement? Let’s just assume for a minute that you’re getting $20,000 a year in Social Security. Social Security is only supposed to represent about 40% of your retirement income. So that means based upon current averages, you’ll need an additional $30,000 a year to meet your basic living requirements during your retirement years. To be able to do this, you will need one million dollars accumulated in invested assets just to be able to get that $30,000 of annual income that you’re going to need to cover that lifestyle. And this one million dollars is only available to be used for your annual distributions. You can’t start using it for shock payments or aspirational expenses that might come up without putting your whole retirement at far greater risk. You might be asking ‘what are my options?’
‘What can I do if I don’t have this much money put aside?’ Historically, many retirees have resorted to one of the following options: save more, spend less, work longer, die sooner or take more risk. Let’s take a minute to talk about each of these.
The first option is to save more. I don’t know about you, but I don’t know a whole lot of people that have a bunch of extra money lying around they can use to save for their retirement. Life is expensive, which is one of the problems that created the underfunded retirement plan in the first place.
The second option is to spend less; isn’t retirement about enjoying those golden years? I know it is for me and for the people I work with. Nobody wants to work 40+ years of their life only to realize that the amazing lifestyle they’ve been living up to retirement is nothing like the lifestyle they will be living during their retirement.
The third option is to work longer. To me, this is the best option. I personally think far too many people retire too early. But this might not be an option for you. If your health starts to fail, or if you’re in a very physically demanding profession, you might not be able to keep working much past the age of 65. This makes it hard for many people to count on this as one of their options.
The fourth option is to die sooner. Now, anyone want to volunteer for this one? I didn’t think so. That being said, based upon current statistics, I should have had some people on this podcast who are willing to take this option. What do I mean? The statistics show that 68% of retirees’ biggest worry is that they’re going to live too long. Another way to look at this is that 68% of retirees would rather be in the casket than in the pew when they attend their next funeral.
The fifth option is to take more risk. There are financial advisors out there who promote this as the best solution, but what would have happened had you taken that risk in 2008? Or how about the beginning of 2020? Are you willing to take the risk of having no retirement just because you’re not happy with the small retirement you’ve already prepared for? If these are the best options most advisors have when it comes to solving the underfunded retirement issue, what should you do? I believe there are two possible solutions and they both involve products that are available through life insurance companies.
The first is a fixed indexed annuity. Due to mortality credits, annuities can be a great way to help you eliminate the 3% withdrawal rate if you haven’t saved up enough money for your retirement. You may find that you can even double your withdrawal rate by using an annuity. This means that you would only need to have $500,000 set aside for your retirement, instead of the one million dollars that I previously mentioned, to get to that same $30,000 of income that you’re going to need to help supplement your Social Security.
The other option is to buy a permanent life insurance policy that we call a life insurance retirement plan. This policy can be used to help you eliminate sequence of returns risk, which is the risk that causes the biggest problem when you’re talking about withdrawal rates. Why is a sequence of returns risks such a problem? It is the risk that the market will go down during the years you have to take money out of your retirement. When this happens, it can wreak havoc on an otherwise well organized and planned out retirement.
If you’ve taken time to do the simple math for your situation and you realize that your retirement might not be looking as good as you thought it would when you consider the 3% rule, I recommend you request an appointment to meet with one of our advisors. They are trained to help you eliminate the risk of retirement and to help you maximize the asset you have available for your retirement.