News flash: You are now allowed to spend retirement savings

Aside from the need to work, toil and slave to salt away one or two million bucks or more, there’s one thing that has long ticked me off about the whole topic of retirement planning — the single-minded focus on accumulation.

Entire libraries could be filled with the books, newspaper pieces, magazine articles, DVDs and CDs devoted to the why, how, when and where to stockpile assets for retirement. (And that’s just counting the stuff from Suze Orman!)

But almost no one focuses on the spending of those assets. There’s no overlooking that oversight, no selling short the impact of that shortcoming. Assuming retirees’ cash reserves will be finite when they saunter off into the sunset, and for most of us they will, wouldn’t it really be kind of nice if we actually knew how much we could safely spend in each of our glittering golden years?

The lack of guidance about how much to “decumulate” does quite a number on many older adults. Having spent a lifetime accumulating a nest egg, in part through high interest savings accounts and zero percent APR credit cards, they now fuss and fret about how much of that nest egg they can nibble away at yearly, without seeing their savings expire before they do.

The result is a ludicrous scenario in which otherwise responsible, level-headed older adults with hundreds of thousands of dollars in assets wring their hands with worry about spending their own savings. Imagine the questions they ask.

Should we buy a new Ford or Toyota, or conserve cash by acquiring a pre-owned 1988 Yugo? Should we replace that old sofa by visiting a nice furniture store, or by launching a midnight raid on a municipal dump? Should we re-use dental floss, whittle toothpicks out of downed tree limbs?

Do we have enough in the summer vacation kitty to exit the county for the first time?

The spending down lowdown

Anthony Webb, a researcher at the Boston-based Center for Retirement Research, decided he would launch a study to determine whether there might be a fairly simple formula to guide people in spending-down decisions.

Webb examined five different approaches, the first being the once-popular “four-percent rule.” That rule of thumb holds that it’s okay for retirees to spend about four percent of the amount they have at the time of their retirement in each year of retirement.

Another strategy tested was one of spending interest and dividends, but not principal. A third concept tied retirees’ withdrawals to their life expectancy. A fourth focused on the strategy of purchasing an annuity to provide guaranteed proceeds on a yearly basis over the course of retirees’ lifetimes.

It was the fifth strategy that delivered a real departure from the been-there, done-that routine. “I said what would happen if instead of following the four-percent rule, the household draws out amounts equal to the Internal Revenue Service Required Minimum Distribution rules?” Webb explained.

The IRS has a table that shows how much older Americans must withdraw each year from their 401ks and IRAs. That schedule of withdrawals is known as the Required Minimum Distribution, better known as RMD. The amounts are mandated because the IRS wants to get its eager hands on tax revenue it didn’t collect when moneys were deposited into the 401ks and IRAs tax free.

The dictated withdrawal percentages increase with age, reflecting that the individuals have fewer years before they will pass away and can, therefore, grab more. For instance, at 65, the percentage is 3.13 percent of year-before assets. That percentage grows to a minimum of 3.65 percent of assets at 70, 4.37 percent at 75, 5.35 percent at 80 and so on.

The envelope, please

In testing these scenarios on real-world households occupied by fretting, nervous retirees, Webb quickly eliminated from consideration the four-percent rule, which saw the last of its champions fall by the wayside during the Great Recession. Why so? Taking four percent or $40, 000 of $1 million in retirement assets in the first year is fine. But what if a market meltdown shrinks that $1 million to $550, 000 in Year Three? Continuing to take $40, 000 a year will soon deplete the nest egg, quickly transforming the leisure-loving retiree into a blue-shirted, 25-hour-a-week Wal-Mart greeter.

Other approaches also fell short, and were too complex to follow. You guessed it. The strategy that proved A-OK, and that many retirees should consider pursuing PDQ, was the RMD. The strategy benefits from its simplicity, in that the IRS RMD tables are easily accessible. It was also a more real-world strategy, because the percentages are applied to the year-earlier principal, not as with the four-percent rule of the principal at time of retirement.

“We tested it for households more or less concerned about the risk of outliving their wealth, ” Webb recalls. “And the strategy that came out best was a strategy of spending the interest and dividends and at the same time drawing out an amount of principal equal to the RMD tables.”

Webb agrees with this blogger that too much attention is devoted to building up nest eggs. “Thrifty, careful types do accumulate money, ” he says. “It really is okay to spend it. That’s what it’s there for. The only question is how rapidly” to draw it down.

9 Responses to “News flash: You are now allowed to spend retirement savings”

  1. Anonymous

    From what I read, and from just now consulting the IRS website, it seems required distributions are not required until the year that one turns 70½.

  2. Anonymous

    I see this with my 90 yr old Mother. She is afraid to spend on anything, worrying about the cost of groceries, minor car repairs. I sat down with her and went over her finances. I told her she can withdraw 4x what she uses annually now, and she could then live to 120 before she’d run out of money. Sigh.

    I think it’s also difficult to live ones life very frugally and then realize, hey, I can have dinner out every [email protected] night and go on a cruise now!

    You work hard for it – SPEND IT!

  3. Anonymous

    Based on your previous advice, I actually swithched to a “method five” last year after trying to figure out an easy way to arrive at a draw rate that takes into account my actual retirement experience and my future estate. I have a single page excel sheet that is amazingly simple to use; I’m willing to share with Mr. Steele. I have developed one for pre-retirement and another for post-retirement. These are free of course.

  4. Anonymous

    Very interesting study. Personally I wouldn’t invest my retirement money in the stock market, mutual funds or any other investments that could lose money at anytime. What I’m doing is invest in buying and renting properties now. By the time I retire (20-25 yrs from now), my mortgages will be fully paid off. I will spend the money that I earn from the cash flow generated by these properties. And don’t forget, the market value for these properties will also appreciate nicely over the years before and after I retire.

  5. Anonymous

    If you were using the 4% rule you don’t have to invest all of your money in the stock market, you could move some of it to bonds or money market funds, so you would never lose half of your retirement. My dad said he always has the next 10 years worth of money in safe investments, then the rest can go up or down with the stock market. He always has time to recover any losses and take out money on the next upswing.
    But I am a little concerned that if I live a long time that 4% will buy a lot less than it did at the beginning of my retirement so I will probably take out 2 or 3% as Nick said above.

  6. Anonymous

    Because my husband and I are both solopreneurs, we won’t be retiring in the traditional sense. We do have IRAs and my husband has reached the age of RMD. But our philosophy has been to not wait to enjoy our life together.

    When I worked in a long-term care facility, I saw a couple who had scrimped and saved their entire married life (with the husband having to travel most of the time for work while the wife stayed home). Their plan to travel the world on his retirement and finally spend time together came to a tragic end when the wife fell and broke her hip the week before they were to leave. The majority of their carefully saved “retirement” money went toward her care. This taught me to be more willing to spend and enjoy NOW, rather than put all pleasure off until a later that may never come.

    My husband and I take go out to lunch, take vacations and pursue hobbies we enjoy — on a cash basis. If we can’t pay for it without credit, it doesn’t happen, but we also know that it is foolish to wait for “some day” to take advantage of the time and assets we have.

    Thanks for the thought-provoking post!

  7. Anonymous

    When I retire I will try to spend 2 to 3% of my nest egg. Most of the money will be invested in safer assets however I want the money to grow ahead of inflation. Great post. Thanks for sharing.

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