by Pete McAllister | Accounting News, News, Retirement
Retirees can determine how much money they can withdraw from their accounts each year without depleting their nest egg prematurely by using the safe withdrawal rate (SWR) method. This approach attempts to balance your expected income needs to live comfortably without the risk of running out of money by withdrawing too much too soon. While it is based broadly on your portfolio’s value at the start of retirement, you must also consider the total amount of your savings and other intended retirement income, including the progressing growth of your investment accounts, as well as your expected expenses each year.
How to Calculate a Safe Withdrawal Rate
The safe withdrawal rate helps retirees figure out a minimum amount to withdraw in retirement to cover basic needs, including housing, electricity, food, and transportation. In 1994 financial planner Bill Bengen came up with the 4% annual withdrawal rate, and this has been used ever since as the rule of thumb when determining the safe withdrawal rate. (In 2018 Bengen amended this amount to 4.5% to account for inflation.) According to the 4% rule, retirees withdraw no more than 4% of their starting balance each year. While this approach isn’t foolproof against depletion, it protects portfolios against market downturns by limiting withdrawal amounts. These limitations give retirees a much better chance of their portfolio enduring the length of their retirement.
To get started you would withdraw 4% in the first year of retirement, then increase that amount by the amount of inflation in following years.
If your nest egg is $200,000:
- Year 1: 4% of $200,000 = $8,000
- Year 2: providing for a 3% inflation rate, you would withdraw $8,240
- Year 3: providing for a 2% inflation rate, you would withdraw $8,404
Of course, you can always make adjustments to these numbers based on stock market performance and the value of your portfolio year to year — increasing the withdrawal rate if your nest egg is growing and decreasing the withdrawal rate if your portfolio value is dropping.
A Shortcoming of the SWR Method
A weak point of the SWR method is that it doesn’t account for economic volatility, asset allocation, and investment returns. Essentially, it’s a blanket method that doesn’t always apply to individual circumstances. A trusted investment advisor can help retirees determine the appropriate safe withdrawal rate based on their unique portfolio.
In Favor of the SWR Method
On the flip side, the safe withdrawal rate method is easy to understand, provides a predictable and steady income, and offers a clear path for retirees to better control their expenses.
While the 4% rule has traditionally protected retirees from running out of money, there are alternative methods that might be a better fit for you. A financial advisor can help determine how much you need to save and how much you can comfortably spend each year to avoid depleting your nest egg too soon.
by Jean Miller | Accounting News, News, Retirement, Retirement Savings
Although retirement planning often involves some guesswork regarding the future of the economy as well as each retiree’s individual circumstances, there are some general misconceptions to avoid in order to be sure you’re building a solid nest egg. We go through these common beliefs below so you are informed when setting goals for retirement.
The 4% Rule is Steadfast
The 4% rule has been regarded as a sound retirement distribution strategy for years. With this method, retirees withdraw 4% from their retirement portfolio during the first year of retirement. The amount then increases each year according to inflation. This method, in theory, should yield a consistent stream of income for at least a 30-year retirement. However, given market expectations—namely, lower projected returns for stocks and bonds—the general consensus is that the 4% rule be amended to 3.3%. This may seem like a small difference, but it could have a big impact on your standard of living. The difference would be even more evident later in retirement, when accounting for inflation.
You Can Live Off Social Security Benefits
Social Security will only replace about 40% of preretirement income. Given that retirees need to replace approximately 80% of preretirement earnings to prevent a significant reduction in quality of life, Social Security Benefits will fall way short of this mark. Make sure your game plan includes additional savings from investment accounts to cover the discrepancy.
You Can Start Withdrawing Social Security at 65 Years Old
When the Social Security Act was signed into law in 1935, it established age 65 as the full standard benefit age. Couple this with the fact that 65 is also the Medicare eligibility age, and Americans have long considered 65 to be the standard retirement age. However, while Medicare eligibility age remains the same, full retirement age (FRA) has since changed. Depending on a retiree’s birth year, their FRA can be anywhere from age 66 and four months to age 67. This means that if you start Social Security at 65 (before your FRA), you will be subject to early filing penalties that could slash a substantial portion of your monthly check. Be sure to check your online Social Security account to be informed of your FRA and the appropriate timeline for claiming benefits.
Saving 10% of Income for Retirement is an Adequate Goal
For decades, workers followed the rule of thumb to save 10% of their salary for retirement. However, longer life spans, lower projected market returns, and the declining value in Social Security benefits have all contributed to the need to save more. It’s important to work with a financial advisor to come up with a personalized plan for retirement goals, but at the very minimum, aim to save 15% to 20% of income.
Medicare Will Provide Sufficient Coverage for Care
Medicare often doesn’t provide enough coverage for seniors ages 65 and older. Factors such as high insurance costs and coverage exclusions contribute to the need for supplemental coverage, such as Medigap. And sometimes seniors find that a Medicare Advantage policy—the private insurance alternative to traditional Medicare—is a better fit. No matter what you ultimately decide, it’s crucial to devote specific funds to medical costs, either in a health savings account or another tax-advantaged retirement account.
by Daniel Kittell | Accounting News, News, Retirement
A retirement withdrawal strategy can help you establish the appropriate amount of money to take out of your investment accounts each year. The amount you decide to make available to yourself will affect your quality of life in retirement, and you want to make sure your withdrawal strategy will protect against your savings accounts running dry. Below we discuss retirement withdrawal strategies that should ideally work together for an optimal distribution plan.
The 4% Rule
If you follow the 4% rule, you will withdraw 4% of your investment account balance in your first year of retirement. Theoretically, by increasing that amount each year in order to keep up with inflation and the rising costs of goods and services, you should have enough money available to maintain a 30-year retirement. The benefit of this approach is that it’s simple and keeps up with inflation. However, the best percentage for each retiree will vary person to person. This method also doesn’t support flexibility to adjust based on the performance of your investments.
Fixed Dollar Withdrawals
With fixed-dollar withdrawals you take the same amount of money out of your retirement account every month, quarter, or year for a set period. For example, you may decide to withdraw $2,000 monthly for the first three years of retirement and then reassess after that time to determine if this is still the best amount for your circumstances. The benefit of this distribution strategy is the predictable income, but it doesn’t account for inflation or a fund’s performance. Withdrawing a fixed dollar amount each month or year could cut into your account’s principal.
Systematic Withdrawals
Using this approach, you withdraw only the income your investments produce from interest or dividends, so your account’s principle remains intact. The benefit of this strategy is that you can be assured your account won’t run dry since the principle isn’t touched. However, your principal needs to be quite sizable to provide income for you to live on. Keep in mind that your income will vary from year to year, depending on market performance, which makes it challenging to create a financial plan.
Create a Floor
The simplified explanation of income flooring is to determine how much income you need to live comfortably for the rest of your life if you didn’t make another penny, and when that lifetime income should begin. First, you need to create your income floor, typically by building up accounts that provide guaranteed income on a regular schedule—Social Security, pensions, and annuities. By creating a strong financial floor, you can rest assured that you will be able to pay at least the necessary expenses in retirement, no matter the volatility of the markets.
Buckets
Implementing a bucket strategy means creating three separate sources of retirement income:
- A savings account that holds approximately three to five years’ worth of living expenses in cash
- Fixed-income securities, including government and corporate bonds or certificates of deposit
- Equity investments and growth funds
To use this approach, you draw from your savings account to cover your expenses and refill that “bucket” with funds from the other two sources of income. This allows you to refrain from selling assets at a loss. You can refill your savings account by selling stocks (as long as the market is up) or by selling your fixed income securities (as long as they’ve performed well). If both of these are down, continue drawing from your savings.
This approach allows you to potentially grow your investment account balance over time, but it can be time-consuming, and you need to use an additional method to figure out the amount you can afford to spend each year.
Account Sequencing
The goals with an account sequence strategy are to:
- Maximize the amount of money you can spend in retirement
- Receive a higher lifetime after-tax income
- Enhance the longevity of your portfolio
- Reduce taxes paid over the course of your retirement
- Eliminate or reduce Social Security benefits from being taxed
- Reduce Medicare premiums
Your tax bracket can heavily influence when to withdraw money from tax-advantaged funds, and the best approach may be to withdraw cash from a combination of savings and investment accounts. This is where the expertise of advisory firms can help you determine the best course of action.
