Broker Check

Retirement Tragedy #2

Maybe you’re already in retirement, or really close to it. You have a $100,000 nest-egg and you’re withdrawing $4,000 per year from it to supplement other sources of income such as a pension, Social Security, maybe some rental income or income from a part-time job. Obviously, if your nest-egg is much larger than $100,000 you may be less inclined to need the part-time job, but let’s use the same simple numbers.


$100,000

 

    $4,000

Withdrawn per year

           4%

Withdrawal rate


We get the 4% withdrawal rate by dividing $4,000 / $100,000 = 4%. This is considered a reasonable withdrawal rate that could allow your nest-egg to be sustainable and perhaps grow a little for inflation. And, historical economic and market growth rates indicate that this scenario is typical over the long-term. But let’s see what happens in another downturn. We’ll use a market decline of 50% again, but let’s also assume that your nest-egg only declines 30% because your advisor doesn’t have all of your money in the stock market. Your advisor has some in the stock market and some in bonds or cash because of the need to be more conservative. Remember, in this scenario you’re already retired. (And if you are in retirement and your advisor hasn’t made that adjustment, we REALLY need to talk.)


  $100,000

 

    X-30%

 

  $70,000

This represents the aforementioned 30% decline in account value.


OK, now you have $70,000 and your advisor says you need to reduce the amount of income you withdraw from the account. Perhaps you can absorb that reduction in income, and perhaps you can’t. (You may be looking at that part-time job now, IF you can find one.) Maybe you can’t reduce your withdrawal amount. Let’s look at the new numbers:


 $70,000

 

 $4,000

Withdrawn per year

   5.71%

Withdrawal rate


We get the 4% withdrawal rate by dividing $4,000 / $70,000 = 5.71%. This is considered a little on the high side for a withdrawal rate. It doesn’t mean you’re definitely going to run out of money, but it will be harder to sustain this withdrawal rate and harder to grow the nest-egg for inflation. What if the decline were greater? What if the withdrawal rate were higher to begin with?

I have seen some people try to use a withdrawal rate of 9%,10% or more and it is not sustainable. Is it possible to sustain that withdrawal rate for the next 20, 30, or 40 years? Usually not.

Don’t let this happen to you. If you’re getting great advice and your nest-egg is adequately protected, by all means keep your advisor. By adequately protected, it means that your withdrawal rate is low, your assets are invested in mostly conservative investments, and when major declines occur you are able to ride it out because your advisor was pro-active enough to minimize losses. But if you’re seeing major declines in your retirement nest-egg, read on.

* This example is hypothetical and for illustrative purposes only.  It does not represent any particular investment account or investment outcome.  Your results will vary. No strategy ensures a profit or protect against loss.