Thursday, September 6, 2018

Where Retirement Income Plans Fall Down

Whether you use the 4% rule for retirement income or some bucketing strategy variant such as my cushioned retirement investing, a fatal flaw lurks, threatening to undermine any sensible plan. This flaw is the number one reason why it makes sense to be conservative with the percentage of your assets you plan to spend each year.

I saw a good example of the problem when I helped a retired family member with her finances. I worked out a safe withdrawal amount each month and set up her portfolio to transfer this amount into her chequing account each month.

Within a year, she needed to make a large withdrawal from her savings. The reason doesn’t matter. It could have been for a car, a grown child who needed money, or something else. The problem was that she wanted to have her cake and eat it too. She wanted a steady income from her savings and to be able to dip into her savings when necessary. The problem is you can’t do both safely.

I don’t think the rest of us are much different. We can understand that we can’t double-dip, but faced with a problem that can be solved with money, it’s easy to decide that just this one time, it’ll be okay. Except that it will happen again and again. It seems that huge pots of money are irresistible.

So, when you’re reading about the latest ideas on how to spend 5%, 6%, or even 7% of your nest egg each year, keep in mind that such aggressive plans allow no room for special “one-time” lump sums. High withdrawal rates already increase the risk of running out of money; adding extra withdrawals makes financial ruin a near certainty. It’s better to have less aggressive monthly withdrawals and admit that occasional needs for lump sums are a possibility.

8 comments:

  1. Perhaps another reason to consider simple annuities... It eliminates the temptation...

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    1. But then again, you could just as easily get a loan on the Annuity income, or better still sell the annuity for a lump sum! (#sarcasm #badadvice #beingaSmartAss )

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    2. @Garth: I tend not to think of the need to dip into savings as the problem. Rather, I see the problem as setting too high a withdrawal rate to allow for the occasional larger withdrawal. As @Alan joked, people with annuities likely spend all their income and then borrow when bigger spending needs arise.

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  2. Having the ability to live to your plans is a skill many of us never really master (speaking as a Project Planner that has problems sticking to my own Project schedules). People need to plan financially based on what they have done in their life, not on what they Wish they would have done. There is no ZEN here, you will not be a better person, you will be YOU, so plan accordingly.

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  3. Without exception everyone's plan will be different. There is NO one size fits all plan. Those who believe this myth also believe humans turn into angels when they die or life is better when your dead than it was when you were alive. I respectfully disagree with the term 'financial ruin' in your example. People adjust to circumstances very well as they arise unexpectedly or planned. They just do.

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    1. @Stockmarket Speculator: While no two plans are identical, there is a lot of commonality, so it's possible to start with a sensible base and modify as necessary. People adjust, but should that be the goal? If you spend 10% of your savings each year in retirement, you'll adjust to ever-lower income, but that doesn't make it a desirable plan.

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    2. Not desirable but realistic. Plans are guidelines, that is the sensible way to look at it.

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