How to retire in luxury
Reprinted courtesy of MarketWatch.com.
To read the original article click here
With several years of retirement under my belt, I’m more confident than ever about the truth of something I wrote some time ago:
“The ultimate financial luxury for a retiree is simple: Having more than enough money to meet your needs.”
It isn’t necessarily easy to achieve, but when you’re retired, having a comfortable margin of savings above what you really must have is about as good as it gets. Let’s look at some numbers to see what I mean.
Last week I wrote about taking fixed distributions in retirement, a discussion that’s built on the assumption that you will need all the retirement income you can get so long as you don’t risk running out of money.
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Today I want to explore a variation on that theme. How much can you take out if you are able to start with more savings?
(You can in effect do this by saving more aggressively while you’re working, retiring later, planning to earn some part-time income in retirement or tightening your belt — or by any combination of those strategies.)
If you have more than you need, I believe you should be able to function comfortably with retirement distributions that go up and down to reflect the returns on your investments.
This flexible distribution plan adjusts your cash flow from year to year as the value of your portfolio goes up and down. In doing that, this plan automatically does something that most smart retirees would naturally want to do if they could: Take out more money after good years and scale back their spending when their investments are struggling.
When your investments are doing well, this is a wonderful plan. But in bad times, it can be tough.
I would like to call your attention to the very first article I wrote for the RetireMentors. This had a very high readership; no surprise given the title: How to double your retirement income in five years.
To make my point adequately, I have to refer you to some tables of historical numbers that you will find here. In particular, I call your attention to Tables 4, 5 and 6, which are concerned with the type of flexible distribution I’ve described.
These tables show what could have happened to somebody who retired in 1970 with a $1 million portfolio. Table 5 is based on the assumption that 5% of the portfolio was withdrawn at the start of every year, based on the portfolio’s value at the end of the prior year. (That’s why it’s variable.)
Several investment allocations are shown, varying from 40% stocks and 60% bonds up to 100% global stocks, and with the Standard & Poor’s 500 Index SPX, -0.24% included for comparison.
You will see that, after 45 years, none of these portfolios was anywhere near the danger zone of running out of money as 2014 came to a close.
But our imaginary investor paid a price for this. If you follow the distribution column for the 60% equity portfolio, you’ll see that the newly minted retiree had to get by with sharply fluctuating income for a few years.
The low point, 1975, provided only $43,461 that year, a significant drop from the initial $50,000. If you really needed $50,000 to cover your cost of living, this had to hurt.
With the benefit of hindsight, we can see now that everything worked out well after 1975. But back then, our hypothetical retiree had no way to know that. Would any intelligent retiree knowingly embark on a withdrawal plan like this?
I think so, which leads me back to my earlier assertion. I think this plan could make great sense to a retiree who had over-saved. Imagine that you had $1.5 million in your portfolio and your needs didn’t exceed $50,000. You could then multiply each of the withdrawals by 1.5. In 1970 you would take out $75,000 instead of $50,000. What a nice kickoff!
At the low point (1975), you would have $65,191 instead of only $43,461. Assuming you kept your cost of living under control, that would be well above your basic needs.
After that, your withdrawals would have risen handsomely: $114,792 in 1980; $169,042 in 1985; and $315,780 in 1990.
And it gets even better than that for the retiree who has saved more than enough, because I think this person could afford to take out 6% instead of 5%. You can see the results of this in Table 6.
Continuing with the 60% equity allocation, the 1975 low distribution was $49,466, just barely below this retiree’s assumed cost of living of $50,000 five years earlier.
But for a retiree who started with $1.5 million and took out 6%, the low point was $74,199, well above his or her $50,000 basic needs even after adjusting for inflation.
And the next dozen years were even kinder to the retiree who could afford to take out 1.5 times the figures in Table 6: $123,918 in 1980; $173,077 in 1985; and $306,655 in 1990.
If you’re paying strict attention to Table 6, you might notice that the 1990 figure of $306,655 (for a 6% withdrawal rate) is actually smaller than the figure for the 5% withdrawal rate, $315,780. What gives?
This relatively small difference results from the cumulative effect of the higher withdrawal rate. Taking out more (6% in this case instead of 5%) ultimately leaves you with less. If we calculate the numbers in the tables out another 10 years to 2000, the $1.5 million saver taking out 6% gets $369,058, while the one taking out 5% gets $422,460.
Is this a bad deal for the retiree taking money out at 6%? I don’t think so, and I’ll tell you why.
Because of inflation, a retiree would have needed $224,026 in the year 2000 to replace $50,000 of spending in 1970 dollars. Whether the retiree had $422,460 (from 5% withdrawals) or “only” $369,058 (from 6% withdrawals), he still had a very ample cushion above his inflation-adjusted basic needs.
In addition, the higher withdrawal rate that was made possible because of ample savings provided significantly higher withdrawals for the first 10 years of retirement. Those are the very years when many retirees are most likely to want to travel and follow other potentially expensive pursuits.
More than anything else, this analysis emphasizes the value of saving more than you think you will need. For a more detailed discussion of how to use these tables to find the right withdrawal strategy for you, check out my podcast on this topic.
If you can retire with more than enough money to meet your basic needs — enough to follow this flexible plan — then you will be in great financial shape. It’s worth a bit of extra savings when you’re working. It’s worth working a little longer if you can. And it’s worth keeping your cost of living under control.
You now have the recipe for the ultimate retirement luxury.
Richard Buck contributed to this article.