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Association of
Ameritech/SBC Retirees
GETTING GOING Burning Through Money in Retirement: A Tale of Three Withdrawal Strategies April 27, 2005; Page D1 Wall Street Journal There's no point sugarcoating it: For many retirees, the past five years have been a financial disaster. How bad has it been -- and is there any way retirees could have softened the blow? To find out, I asked Baltimore fund manager T. Rowe Price Group to analyze how a couple, both age 65, would have fared if they had retired at year end 1999 with a $500,000 nest egg. Sure, if our couple had everything in bonds, the numbers would look dandy. But today, the standard advice is that retirees should keep maybe half their nest egg in stocks, so their income has a shot at keeping pace with inflation over a retirement that might last 30 years. With that in mind, I assumed our couple's $500,000 was split between 35% intermediate-term bonds, 10% cash investments, 40% U.S. stocks, 10% foreign shares and 5% real-estate securities. T. Rowe Price then took that portfolio and applied three common withdrawal strategies. 1. Starting small. With the first strategy, our couple marries a 4.5% initial withdrawal rate with automatic inflation increases. In other words, their total first-year withdrawal -- including dividends and interest -- would equal 4.5% of their $500,000, or $22,500, and thereafter they would step up that sum each year with inflation. This may not sound like a whole lot of income. Even so, the rising withdrawals put a big dent in the portfolio's value, especially when combined with the lousy returns of 2000 to 2002. In fact, as you can see from the accompanying chart, the portfolio would have fallen below $400,000 by year end 2002, no doubt terrifying our poor couple. The subsequent stock-market rebound undid some of the damage but, by year end 2004, the portfolio was still worth just $457,000. 2. Taking five. Next, T. Rowe Price tested a 5% initial withdrawal rate, giving our couple $25,000 in the first year. But with this strategy, our couple skips their annual inflation increase if their portfolio had an investment loss the prior year, meaning their nest egg shrank by more than the sum withdrawn. That happened twice. Our couple's funds posted an overall investment loss of 2.3% in 2001 and 7.1% in 2002. In both years, the broad stock market suffered a double-digit drubbing. But our couple's bonds, real-estate securities and cash investments posted gains, thus limiting the damage. Still, the second strategy was, if anything, riskier than the first. It generated $10,000 more income over the five years but, by year end 2004, our couple's portfolio was worth just $445,000. 3. Playing the percentages. To avoid such a big hit, our couple might have simply withdrawn a fixed 5% of their portfolio's beginning-of-year value each and every year. This third strategy forces our couple to trim their withdrawals when their portfolio shrinks. Indeed, their income would have fallen from $25,000 in 2000 to $19,900 in 2003, before bouncing back to $22,300 last year. Yet these income cuts didn't help that much. At year end 2004, our couple's portfolio was worth $463,000, well below the initial $500,000. And now for some startling statistics: Suppose our couple wanted to finish 2004 with their $500,000 intact. If they used the first strategy, they would have had to limit their initial 2000 withdrawal rate to 3.1%, giving them first-year income of just $15,500. Similarly, they would have had to adopt a 3.2% initial rate with the second strategy and settle for a fixed 3.5% with the third strategy. Why do I keep harping on the portfolio's value at the end of 2004? No, I am not advocating the old rule that you should "never dip into principal." If our couple invests in stocks, they will inevitably suffer some losing years. Moreover, as they approach age 80, I wouldn't be too concerned if their portfolio fell permanently below $500,000. In the examples above, however, our couple has reached age 70 -- and their portfolio is already well below $500,000. To be sure, they could get back on track if they clock healthy returns in the years ahead, or maybe cash out some of their home equity. But without either sizable stock or real-estate gains, there is a serious risk our couple will run out of money. Don't want to end up in such dire straits? There are a bunch of strategies that could help. If you get hit with a brutal bear market, tap your bonds for income, while leaving your stocks to recover, advises T. Rowe Price money manager Ned Notzon. He says you might also get part-time work and defer expenses. "Instead of taking the trip around the world, take some community-college classes," Mr. Notzon suggests. In testing the three strategies, T. Rowe Price assumed our couple incurred 1% a year in fund expenses. You could improve your results somewhat by favoring cheaper funds. You might also opt for a lower withdrawal rate if you retire at a time of modest bond yields or lofty stock valuations. That was clearly the case in early 2000, and it's still the case today. Finally, while any of the three strategies above may be a good starting point, don't follow them slavishly. In fact, be prepared to slash your portfolio withdrawals if you get hit with terrible markets, especially if those rotten markets strike early in retirement. To that end, add up your Social Security and pension income. If that isn't enough to pay your basic living expenses, consider buying an immediate annuity from an insurance company, thereby purchasing additional monthly income that is guaranteed for life. Your goal: to have enough regular income to cover the basics, so you aren't forced to dip into your portfolio when markets turn rough. |