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Diem Wealth Management

How Much Income Can I take From My Investments and Not Run Out of Money?

One of the most satisfying parts of my work is teaching a Baby Boomer Retirement course. Along with investments and long-term care planning, sequence of returns risk is near the top for generating much discussion with the students.

Think of sequence of returns as not just your average annual rate of return being important but also the order of how your returns happen. To illustrate this concept, a chart using hypothetical returns and people should serve as an aid.

Setting out to generate a lifetime inflation adjusted income our two couples have saved and invested $500,000.

Both couples of the same age started out with the same withdrawal strategy. They withdrew 5% of their accounts in the first year, then increased the withdrawal amount every subsequent year in an attempt to offset inflation.The withdrawals were inflated 3% annually.

Both couples earned the same average annual return (a commonly used measure of performance).

Both couples had strikingly different results.

Dave and Joan ran out of money while Jeff and Wendy became millionaires.

Why would this be true?


The only difference is Dave and Joan had poor investment performance early in their retirement and good performance toward the end. Jeff and Wendy, conversely, had good performance early and poor results later in their retirement.  This one difference was enough to exhaust Dave and Joan’s nest egg while Jeff and Wendy became millionaires enjoying a growing retirement income.

A number of rules of thumb have been used to answer this question.

In 1994, William Bengen’s seminal work on safe withdrawal rates changed the way many people planned their retirements. This idea became the most oft used rule of thumb by advisors. Bengen's rule allowed a withdrawal rate of no more than 4.2%. Throw in annual adjustments for inflation and a retiree would not run out of money during a 30-year retirement. This was tested using historical rates of return (1926 to 1994) in a 60%/40%- Stock/Bond portfolio.

A lot has changed since then. Falling interest rates to near zero and a couple of nasty bear markets have caused more than a few to question the validity of this long-standing idea.  

T. Rowe Price published a more conservative portfolio withdrawal rate strategy. Their idea is to invest more conservatively by using a 25%/75%-Stock/Bond Portfolio. With this very conservative mix T. Rowe recommends a lower 3.2% withdrawal rate.

The T. Rowe conservative retirement strategy has some drawbacks of its own. This portfolio would require 75% of the portfolio to have a very low expected return. At the time of this writing, yield for the 10-year US Treasury Note has again dipped below 2%.

Even if the T. Rowe strategy works out, a retiree would accept a $32,000 annual inflation adjusted income for their million dollar net egg.

There are a number of annuity strategies that are gaining traction with advisors. Think of fixed annuities for their strong principal guarantees and variable annuities adding a markets based risk and return element.

When using a  fixed annuity for income one must understand what is under the hood in these products. Mostly bonds. The underlying bond maturities are set to match either the contract's surrender charge period (usually 5 to 12 years) or its expected income payout period (which could be the rest of your life). With historically low interest rates it would not be a very good idea to buy either longer-term bonds or longer-term annuity products.

Another idea put forth by advisors is income secured by guaranteed benefit withdrawal riders. These riders are often attached to a Variable Annuity contract. When its all totaled, expect the fees to come in near 4% per year.  Sequence of returns risk also applies to fees withdrawn from your account. These products do guarantee an income, often 4%-5% for life but there is the possibility of nothing left over for your heirs. That said, assuming a zero balance and you living to your expected mortality, count on a return of just over 1%. Your own deposits would have funded the remainder of the income you received. Ouch!

In the end, low interest rates and volatile markets negatively affect retirees today.  Sound financial management is more crucial today than ever.  I help people better understand how to successfully navigate these waters without overpaying. Give me a call to set up a time for your free one-hour consultation. You will walk away with useful ideas.