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How Much Is Too Much? Protecting Against Running Out of Money in Retirement

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In survey after survey, workers nearing retirement and those in retirement reconfirm that the financial risk they fear the most is running out of money as they age. The fear isn’t unjustified or unrealistic. While the numbers vary slightly from study to study, the result is always similar. The average worker is arriving at retirement’s doorstep with less money saved than they need.

According to the Social Security Administration, income in retirement comes from four main sources: Social Security payments, earned income, income from assets, and pension payments. Our focus in this post is the portion of income that is derived from assets, like retirement accounts. One of the most common questions we’re asked is “How much money can I take out of my accounts each year without running out?”

For years, the financial community has recommended that investors withdraw 4% from their portfolios each year and adjust for inflation annually. Lately, however, the rule of thumb has come under increased scrutiny due to the combined factors of longer lifespans and the recent prolonged period of low interest rates. As in so many cases in financial planning, the one-size-fits-all answer simply doesn’t seem to meet the individual investor’s needs. Guidelines and general rules are helpful, but to really get the right answer, we must consider each situation individually. Retirees should contemplate the following factors as they plan their income strategy:

  • Length of Time Assets Need to Last: In other words, when does retirement occur and how long is it expected to last? Retiring at 60, rather than 67 or 70, has a range of implications. First, saving money into retirement accounts stops, robbing the account of valuable contributions. Second, years of potential growth are lost. Rather than experiencing a compounding effect, growth is removed from the account and used to pay living expenses. Third, the length of time that assets must produce income and combat inflation are greater. For the well-prepared early retiree, these factors may not pose a problem. But for those who are underprepared or walking a fine line, a year or two of continued work may make all the difference.
  • Risk Tolerance and Investment Allocation: In today’s low interest rate environment, conservative investors are feeling the worst of the impact of low yields. Bonds and CDs that used to grow at rates of 4 or 5 percent are now returning 1 or 2 percent, or even less. As a result, conservative investors are facing a choice: reduce living expenses or dip into principal to maintain their current standard of living. The third option: adjust their investment allocation to accept more risk in hopes of achieving the higher returns needed to support their lifestyle. As part of the conversation surrounding safe withdrawal rates, investment experts have tested hypothetical portfolios to determine the optimum mix of stocks, bonds, and cash-like assets that are most likely to sustain distributions over long periods of time. The consensus? Retirees who wish to protect against withdrawing principal must have a significant portion of their assets invested in growth-oriented investments, like stocks.
  • Expectations: When asked about what they expect retirement to look like, most workers nearing retirement describe all of the things they’ve been looking forward to doing, like traveling, golfing, and picking up hobbies. Most retirees have big dreams, and curtailing expenses heading into retirement usually isn’t part of the picture. Investors should spend time creating anticipated spending plans and evaluating their ability to stick with their plan. Managing expectations early in the planning process can be helpful in ensuring that retirees are armed with the knowledge and restraint required to see them through their lives with portfolios intact.

We suggest working closely with your advisor to create a strategy for retirement. Remember, start planning early and review often. Time is your greatest asset.

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