Retirement spending: Safe rates
Joel Dresang: Art, you generally recommend that retirees set a distribution rate at which they can safely take their money out of their savings, and you do that so that they don’t have to worry about spending in retirement and outliving their money. What’s a safe rate?
Art Rothschild: Joel, that will vary from individual to individual, but we generally consider 4% to 5% to be a safe starting point.
Joel: Where does that come from?
Art: It comes from really the application of three factors. We expect a well-balanced portfolio to provide returns of about 6% to 8%. We like to reserve about 2% to 4% as a cushion because of inflation, and then we want to make sure that the retiree doesn’t outlive their principal.
Joel: So that distribution rate, let’s say 4%, would come from the retiree’s investments. That would be in addition to whatever they would be getting from Social Security or pension payments. Are there exceptions to that 4% rule?
Art: Joel, there are exceptions, but we always want to start with a safe rate. We’re trying to protect principal so that we make sure that the retiree doesn’t outlive what they’ve accumulated for retirement.
Joel: So what about the stock market? Is that a factor? If the market goes way up, can I spend more than the 4%, or if it’s not doing as well, I spend less?
Art: We don’t want to have the stock market’s ups and downs be considered. We set the rate based upon the assumption that stocks do go up and down. Volatility is part of investing.
Joel: So what are some of the reasons that you would make exceptions?
Art: There are really three types of exceptions. If someone has a lower risk tolerance, if someone has a different time horizon for their money and if they have different objectives or, for example, need more money to spend in retirement.
Joel: So explain that a little bit more. Risk tolerance. How does that matter for a retiree’s withdrawals?
Art: Some individuals can’t stomach the volatility that comes from a, for example, 60% allocation to stocks. So if an individual has to have less of their money in the stock market, they should correspondingly expect to make less. If they’re making less, we can’t assume that same 4% to 5% distribution.
Joel: And what about time horizon? So if I’m much older, can I spend more than that 4%?
Art: The older you are, the closer you get to when you’re going to meet your maker, actuarially speaking. But you have to be very cautious because there are unexpected spending requirements that happen as we get older. For example, health emergencies. So I’d be very careful about overspending.
Joel: And then as far as objectives, if I wanted to spend through my principal and not worry about leaving an inheritance, I could spend more?
Art: You definitely can but again, I’d still be careful in overspending because you don’t really know what your final expenses are going to be, and heaven forbid you die broke. It’s not a good way to go.
Joel: So this distribution rate, 4% or whatever, that’s a rule of thumb, and it varies based on individual circumstances. And I guess like any rule of thumb, it’s important to understand the rule and know what the consequences are if you violate it.
Art: Joel, that’s correct. It’s a safe starting point. We always want to start with something that’s safe. Variations from that rule, as you indicate, will have consequences, so we’re trying to control the controllables. We can control our reaction to the markets, we can control what we spend. We can’t control the markets themselves. So having a safe distribution rate, as a good starting point for long-term retirement distribution planning, does help us to have a comfortable retirement.
Art Rothschild is vice president and investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Safe investment withdrawals for retirees, a Money Talk Video with Art Rothschild
Deciding which retirement accounts to tap, a Money Talk Video with Dave Sandstrom
Retirement spending with heirs in mind, a Money Talk Video with Dave Sandstrom
Retirement requirement: Distributions, a Money Talk Video with Dave Sandstrom
When should I …take my required minimum distribution? by Chris Evers
FAQs about RMDs, from the IRS
Selecting Retirement Payout Methods, from the Financial Industry Regulatory Authority
(initially posted March 21, 2018)