how much annual income can your retirement portfolio provide
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This is indeed the Million dollar question. Many people leave their Broker to seek the advice of a Financial Planner to help answer their personal question, do I/we have enough money to live comfortably? This important question needs the knowledge and experience of more than just an investment manager. It takes two separate skill sets , accumulation and distribution.TRANSCRIPT
Dolf Dunn Wealth Management, LLCDolf Dunn, CPA/PFS,CFP®,CPWA®,CDFA
Private Wealth Manager11330 Vanstory Drive
Suite 101Huntersville, NC 28078
How Much Annual Income Can Your Retirement PortfolioProvide?
April 01, 2014
Your retirement lifestyle will depend not only on yourassets and investment choices, but also on howquickly you draw down your retirement portfolio. Theannual percentage that you take out of your portfolio,whether from returns or the principal itself, is knownas your withdrawal rate. Figuring out an appropriateinitial withdrawal rate is a key issue in retirementplanning and presents many challenges.
Why is your withdrawal rateimportant?Take out too much too soon, and you might run out ofmoney in your later years. Take out too little, and youmight not enjoy your retirement years as much as youcould. Your withdrawal rate is especially important inthe early years of your retirement; how your portfoliois structured then and how much you take out canhave a significant impact on how long your savingswill last.
Gains in life expectancy have been dramatic.According to the National Center for Health Statistics,people today can expect to live more than 30 yearslonger than they did a century ago. Individuals whoreached age 65 in 1950 could anticipate living anaverage of 14 years more, to age 79; now a65-year-old might expect to live for roughly anadditional 19 years. Assuming rising inflation, yourprojected annual income in retirement will need tofactor in those cost-of-living increases. That meansyou'll need to think carefully about how to structureyour portfolio to provide an appropriate withdrawalrate, especially in the early years of retirement.
Current Life Expectancy EstimatesMen Women
At birth 76.2 81.0
At age 65 82.7 85.3
Source: National Vital Statistics Report, Vol. 61, No.4, May 8, 2013
Conventional wisdomSo what withdrawal rate should you expect from yourretirement savings? The answer: it all depends. Aseminal study on withdrawal rates for tax-deferredretirement accounts (William P. Bengen, "DeterminingWithdrawal Rates Using Historical Data," Journal ofFinancial Planning, October 1994) looked at theannual performance of hypothetical portfolios that arecontinually rebalanced to achieve a 50-50 mix oflarge-cap (S&P 500 Index) common stocks andintermediate-term Treasury notes. The study took intoaccount the potential impact of major financial eventssuch as the early Depression years, the stock declineof 1937-1941, and the 1973-1974 recession. It foundthat a withdrawal rate of slightly more than 4% wouldhave provided inflation-adjusted income for at least30 years. More recently, Bengen used similarassumptions to show that a higher initial withdrawalrate--closer to 5%--might be possible during the early,active years of retirement if withdrawals in later yearsgrow more slowly than inflation.
Other studies have shown that broader portfoliodiversification and rebalancing strategies also canhave a significant impact on initial withdrawal rates. Inan October 2004 study ("Decision Rules and PortfolioManagement for Retirees: Is the 'Safe' InitialWithdrawal Rate Too Safe?," Journal of FinancialPlanning ) Jonathan Guyton found that adding assetclasses such as international stocks and real estatehelped increase portfolio longevity (although thesemay entail special risks). Another strategy thatGuyton used in modeling initial withdrawal rates wasto freeze the withdrawal amount during years of poorportfolio performance. By applying so-called decisionrules that take into account portfolio performancefrom year to year, Guyton found it was possible tohave "safe" initial withdrawal rates above 5%.
A still more flexible approach to withdrawal ratesbuilds on Guyton's methodology ("Using DecisionRules to Create Retirement Withdrawal Profiles,"
More ways to helpstretch your savings
• Don't overspend early inyour retirement
• Plan IRA distributions soyou can preservetax-deferred growth aslong as possible
• Postpone taking SocialSecurity benefits toincrease payments
• Adjust your assetallocation
• Adjust your annualbudget during yearswhen returns are low
Page 1 of 2, see disclaimer on final page
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2014
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for anyindividual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performancereferenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with aqualified tax advisor.
Securities offered through LPL Financial, Member FINRA/SIPC
Journal of Financial Planning, August 2007). WilliamJ. Klinger suggests that a withdrawal rate can befine-tuned from year to year, using Guyton's methodsbut basing the initial rate on one of three retirementprofiles. For example, one person might withdrawuniform inflation-adjusted amounts throughout his orher retirement. Another might choose to spend moremoney early in retirement and less later; still anothermight plan to increase withdrawals as he or she ages.This model also requires estimating the odds that theportfolio will last throughout retirement. One retireemight be comfortable with a 95% chance that his orher strategy will permit the portfolio to last throughoutretirement; another might need assurance that theportfolio has a 99% chance of lifetime success. Thestudy suggests that this more complex model mightpermit a higher initial withdrawal rate, but also meansthe annual income provided is likely to vary more overthe years.
Don't forget that all these studies were based onhistorical data about the performance of various typesof investments. Given market performance in recentyears, many experts are suggesting being moreconservative in estimating future returns.
Note: Past results don't guarantee futureperformance.
Inflation is a major considerationFor many people, even a 5% withdrawal rate seemslow. To better understand why suggested initialwithdrawal rates aren't higher, it's essential to thinkabout how inflation can affect your retirement income.
Here's a hypothetical illustration; to keep it simple, itdoes not account for the impact of any taxes. If a $1million portfolio is invested in an account that yields5%, it provides $50,000 of annual income. But ifannual inflation pushes prices up by 3%, moreincome--$51,500--would be needed next year topreserve purchasing power. Since the accountprovides only $50,000 income, an additional $1,500must be withdrawn from the principal to meetexpenses. That principal reduction, in turn, reducesthe portfolio's ability to produce income the following
year. In a straight linear model, principal reductionsaccelerate, ultimately resulting in a zero portfoliobalance after 25 to 27 years, depending on the timingof the withdrawals.
Volatility and portfolio longevityWhen setting an initial withdrawal rate, it's importantto take a portfolio's ups and downs into account--andthe need for a relatively predictable income stream inretirement isn't the only reason. According to severalstudies in the late 1990s by Philip L. Cooley, Carl M.Hubbard, and Daniel T. Walz, the more dramatic aportfolio's fluctuations, the greater the odds that theportfolio might not last as long as needed. If itbecomes necessary during market downturns to sellsome securities in order to continue to meet a fixedwithdrawal rate, selling at an inopportune time couldaffect a portfolio's ability to generate future income.
Making your portfolio either more aggressive or moreconservative will affect its lifespan. A more aggressiveportfolio may produce higher returns but might alsobe subject to a higher degree of loss. A moreconservative portfolio might produce steadier returnsat a lower rate, but could lose purchasing power toinflation.
Calculating an appropriatewithdrawal rateYour withdrawal rate needs to take into account manyfactors, including (but not limited to) your assetallocation, projected inflation rate, expected rate ofreturn, annual income targets, investment horizon,and comfort with uncertainty. The higher yourwithdrawal rate, the more you'll have to considerwhether it is sustainable over the long term.
Ultimately, however, there is no standard rule ofthumb; every individual has unique retirement goals,means, and circumstances that come into play.
Tax considerations
Prolonging your savingsmay require attention to taxissues. For example, howwill higher withdrawal ratesaffect your tax bracket? Anddoes your withdrawal ratetake into account whetheryou will owe taxes on thatmoney?
Also, if you must sellinvestments to maintain auniform withdrawal rate,consider the order in whichyou sell them. Minimizingthe long-term taxconsequences ofwithdrawals or the sale ofsecurities could also helpyour portfolio last longer.
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