At retirement, individuals stop working and no longer get employment earnings, and enter a phase of their lives, where they rely on the assets they have accumulated, to supply money for their spending needs for the rest of their lives. Retirement spend-down, or withdrawal rate, is the strategy a retiree follows to spend, decumulate or withdraw assets during retirement. Retirement planning aims to prepare individuals for retirement spend-down, because the different spend-down approaches available to retirees depend on the decisions they make during their working years. Actuaries and financial planners are experts on this topic.
Importance More than 10,000 Post-World War II baby boomers will reach age 65 in the United States every day between 2014 and 2027. This represents the majority of the more than 78 million Americans born between 1946 and 1964. As of 2014, 74% of these people are expected to be alive in 2030, which highlights that most of them will live for many years beyond retirement. By the year 2000, 1 in every 14 people was age 65 or older. By the year 2050, more than 1 in 6 people are projected to be at least 65 years old. The following statistics emphasize the importance of a well-planned retirement spend-down strategy for these people:
87% of workers do not feel very confident about having enough money to retire comfortably. 80% of retirees do not feel very confident about maintaining financial security throughout their remaining lifetime. 56% of workers have not tried to calculate their income needs in retirement. 49% of workers over age 55 have less than $50,000 of savings. 35% of workers are not currently saving for retirement. 25% of workers have not saved at all for retirement.
Longevity risk
Individuals each have their own retirement aspirations, but all retirees face longevity risk – the risk of outliving their assets. This can spell financial disaster. Avoiding this risk is therefore a baseline goal that any successful retirement spend-down strategy addresses. Generally, longevity risk is greatest for low and middle income individuals. The probabilities of a 65-year-old living to various ages are:
Longevity risk is largely underestimated. Most retirees do not expect to live beyond age 85, let alone into their 90s. A 2007 study of recently retired individuals asked them to rank the following risks in order of the level of concern they present:
Health care costs Inflation Investment risk Maintaining lifestyle Need for long-term care Outliving assets (longevity risk) Longevity risk was ranked as the least concerning of these risks.
Withdrawal rate
A portion of retirement income often comes from savings, sometimes referred to as a nest egg. Analyzing one's savings involves a number of variables:
how savings are invested (e.g., cash, stocks, bonds, real estate), and how this changes over time inflation during retirement how quickly savings are spent – the withdrawal rate Often, an investor will change some of their investment types as one ages. A common strategy to replace more risky investments with less risky investments as one gets older. A "risky" investment is an investment that has a higher potential return but also a higher potential loss. A "conservative" investment is an investment with a low potential return but a lower potential loss. A number of approaches exist to assist with choosing the correct risk level, for example, target date funds. A common rule of thumb for withdrawal rate is 4%, based on 20th century American investment returns, and first articulated in Bengen (1994). Bengen later stated the 4% guideline was intended as a "worst case scenario" for retirees in United States, using a hypothetical example of someone who retired in 1968 at a stock market peak before a protracted recession period and high inflation through the 1970s. In that scenario, a 4% withdrawal rate allowed the investor's funds to last 30 years. Historically, Bengen says closer to 7% is an average safe withdrawal rate and at other times withdrawal rates up to 13% have been feasible. A 4% withdrawal rate is also one conclusion of the Trinity study (1998). This particular rule and approach have been heavily criticized, as have the methods of both sources, with critics arguing that withdrawal rates should vary with investment style (which they do in Bengen) and returns, and that this ignores the risk of emergencies and rising expenses (e.g., medical or long-term care). Others question the suitability of matching relatively fixed expenses with risky investment assets. New dynamic adjustment methods for retirement withdrawal rates have been developed after Bengen's 4% withdrawal rate was proposed: constant inflation-adjusted spending, Bengen's floor-and-ceiling rule, and Guyton and Klinger's decision rules. More complex withdrawal strategies have also been created. To decide a withdrawal rate, history shows the maximum sustainable inflation-adjusted withdrawal rate over rolling 30-year periods for three hypothetical stock and bond portfolios from 1926 to 2014. Stocks are represented by the S&P 500 Index, bonds by an index of five-year U.S. Treasury bonds. During the best 30-year period withdrawal rates of 10% annually could be used with a 100% success rate. The worst 30-year period had a maximum withdrawal rate of 3.5%. A 4% withdrawal rate survived most 30 year periods. The higher the stock allocation the higher rate of success. A portfolio of 75% stocks is more volatile but had higher maximum withdrawal rates. Starting with a withdrawal rate near 4% and a minimum 50% equity allocation in retirement gave a higher probability of success in historical 30 year periods. The above withdrawal strategies, sometimes referred to as strategic withdrawal plans or structured withdrawal plans, focus only on spend-down of invested assets and do not typically coordinate with retirement income from other sources, such as Social Security, pensions, and annuities. Under the actuarial approach described below for equating total personal assets with total spending liabilities to develop a sustainable spending budget, the amount to be withdrawn from invested assets each year is equal to the amount to be spent during the year (the spending budget) reduced by income from other sources for the year.
Sources of retirement income Individuals may receive retirement income from a variety of sources:
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