August 17, 2022 – After reaching record highs, the stock market is down almost 12% this year. Perhaps just as bad, inflation is raging at over 8%. Both of these developments make for a terrible situation for retirees, especially for those just beginning their retirement and worried about outliving their money.
It is far easier to predict how long your savings will last in a stable environment with low inflation and friendly stock and bond markets. Unfortunately, that is definitely not the case now. Our hope is that the tips and suggestions in this article might help people better negotiate these tricky times.
Tried and true – the 4% rule
Although there are many theories on how to take distributions from your retirement portfolio, the most enduring is the 4% rule. Most experts agree you probably won’t outlive those savings if you take that much out each year (and some say 5% is also a safe number). But these are only general rules, and unusual circumstances like we are having now can upend them.
For younger workers, a downturn like we are having now doesn’t have much of an effect, as they have a longer time frame for things to even out. But for someone just entering retirement, this can be a serious problem, as they need money now.
As an example of what can go wrong, let’s say you had retirement savings of $250,000 the year before you retire. You plan to take out 4% the first year of your retirement, which will add $10,000 to your Social Security and any other retirement income. But if those savings declined by 6% by the time you start retirement, you will actually only have $235,000. Taking 4% of that would only yield $9,400. Making that worse is that with 8 or 9% inflation, that $9,400 is only worth $8,648.
After that distribution the value of those savings, if the market did not go up or down, would be worth $225,600. That would lead to a 4% distribution of $9,024 (before inflation) in the following year, beginning a vicious, downward spiral for the rest of your retirement.
A recent NY Times article, “The Tricky Math of Retiring into a Downturn“, outlined some options to the 4% rule that might be able to help in this situation.
Reframing. The TImes article suggested that retirees who face a down market and high inflation should consider what they really need, as opposed to what they would like to have. That might suggest only taking out enough to fund real needs, and postponing a big trip or major purchase. That strategy would be a way to preserve capital and wait for markets to recover.
Keep a cash bucket. This is harder to do but can be very useful if you can swing it. If you have enough to fund a year’s worth of expenses not covered by your Social Security or pension, using it now could avoid having to invade your savings in a down market.
Be flexible. Up and down markets can affect how much you can safely take out of your savings. If the inflation adjusted value of your retirement investments drops below what it was when you first retired, taking out 4% will result in a withdrawal amount higher than what you originally calculated. In this case, it might be a good year to take out less than 4%. On the other hand, if the market surges and your investments are worth more than expected, then you can probably afford to take out a higher percentage. If the market drops after that, the loss won’t feel so bad because you got to enjoy the money. One rule of thumb suggested by experts is to divide your retirement savings by the number of retirement years you need to fund. That calculation is how much you can probably safely take out each year. As an example: if you have $250,000, are now 70, and hope to live to 95, then you can take out $10,000 per year ($250,000 divided by 25 years).
One of most retirees’ greatest fears is outliving their money. The double whammy of high inflation and a declining stock market increase the risk of that happening, particularly for someone just starting retirement. People need to be flexible in difficult times in order to be safe for the long term.
Comments? Do you think your savings will last long enough to fund your retirement? Have you faced a tanking stock market and high inflation before? What will be your strategies for coping?