For many baby boomers one of the questions we have always loved to debate is about to change. The old question was – how much do we need to accumulate in savings to afford a comfortable retirement? The old question had a corollary which is also changin – when will we be able to retire and start spending?
These questions will change direction because retirement is either here for a lot of us boomers, or it will be here within just a few years. We will have saved and invested what we did, and that is what we have to work with. for many of us, our traditional careers are over. So now the question has mutated into – how much can we safely spend each year and not run out before we die in 30 years or so from now. The decision is a momentous one, because if we miscalculate we might end up working as a greeter at Walmart to make ends meet. Or almost as bad, we will reach the age when we can no longer do anything with a pile of money, but regret that we never took the trips or had the fun we actually could have afforded.
According to several financial analysts inteviewed in the New York Times, (How Retirees Can Spend Enough, But Not Too Much) the question of how much we can take of our 401ks, IRAs, and other retirement savings isn’t that clearcut. And it has even gotten a lot murkier since the recent stock market crash. Will our portfolios ever get back to where they were? Will future returns be assured as they have been in the past?
A rule of thumb used to be that 4% or 4.5% of the principal a year was the right number. So say we had savings of $200,000, that means that we could withdraw $9000 a year and add that to our Social Security and any other pension income. Using that formula we would be able to keep up with inflation, so every year we could safely give ourselves a 4 or 4.5% raise.
Now some experts are questioning that rule of thumb. Some suggest that the right withdrawal rate might be 5 or even 6%. As you might expect, after the experience of this down market that type of thinking has given a lot of people the willies.
Michael E. Kitces is a financial planner with Pinnacle Advisory Group and Jonathan Guyton is with Cornerstone Wealth Advisors in Edina, MN. They have different approaches to setting a withdrawal figure, although they share one principle: flexibility might be the key to finding the right number. If the stock market is overvalued, it might be a good year to take a little extra out of your retirement fund – maybe even 5.5 – 6.5%. The thinking is the market is about to head down anyway, might as well spend it as lose it. Similarly, if the market is severely beaten down (sound familiar?), then we might be looking at a good belt-tightening year. Save the capital now and it will probably come back. Guyton has another idea we like. Carve out a separate discretionary fund for special trips, projects, or down years. His idea gives us some fun money, we just have to realize that once it is gone it is gone.
Also Robert Shiller’s data used in this story