Retirement Income Studies

You could spend as much time in retirement – 30 or even 40 years – as you have spent saving for it. That is why planning for your retirement savings to generate income is critical. Developing a solid plan and appropriate investments for years of income is well worth your efforts.

                          Muni Cable, San Francisco, California

                          Muni Cable, San Francisco, California

For example, switching your investing approach from growth to conservative to protect yourself against volatility on the eve of retirement may not be the most prudent financial decision anymore. After all, because of inflation and the increased odds that you could live well into your 90’s, conservative thinking may threaten your long term financial security. Preparing your portfolio for retirement is, in large part, about finding the right balance of growth and income to keep your assets working throughout retirement. It is about trying to protect against inflation and trying to make sure you will have income if you outlive the averages. Finally, it is about an appropriate asset allocation, including equity investments, to meet both your current and future income needs.

Equity investments generally involve greater risk than other investments, including the risk of possible loss of principal. However, we would like to present you with some alternative options that may keep your portfolio working hard as you enjoy retirement. It is more than just a retirement portfolio…it is your future income source. If you are concerned about income throughout retirement, it may be time to re-engineer your portfolio to generate an income stream for 30 to 40 years.

So what is a reasonable percentage to withdraw on an annual basis? One study looked at that question based on actual market returns from 1926 to 1976. The study concluded that to ensure your assets lasted for 50 years, your initial withdrawal rate should be no higher than 3% to 3.5%, with subsequent withdrawals adjusted for inflation. To ensure assets last 30 years, the initial withdrawal rate could increase to 4%. These withdrawal rates assumed a stock allocation of 50% to 75% of the total portfolio. Due to the possibility of a major market decline soon after retiring, the study did not recommend stock allocations over 75% (Source: Journal of Financial Planning , March 2004).

Another study took a different approach to this question. By adding other asset classes to the portfolio, including international equities and real estate, and establishing fixed rules for rebalancing the portfolio, this study concluded that to last 40 years, the initial withdrawal rate could be 4.4% with a 65% weighting in equities and 5% with an 80% weighting in equities. If the retiree was willing to forego increases in withdrawals in certain circumstances, such as when the portfolio's ending balance is lower than its beginning balance, and limit inflation increases to 6%, withdrawal rates could increase to 5.1% to 5.8% (Source: Journal of Financial Planning , October 2004).

What conclusions can be drawn from these studies?

  • Your withdrawal percentage should be modest to ensure you don't deplete your assets. While the two studies reach different conclusions, they advocate initial withdrawals of modest amounts ranging from 3% to 5.8%. With a $1,000,000 portfolio, that means your initial withdrawal will range between $30,000 and $58,000. You need to carefully look at your assumptions before deciding between the high or low end of these estimates.
  • Equity need to remain a significant component of your portfolio after retirement. Both studies were based on stock allocations of at least 50% and up to 80% of the total portfolio. With lower allocations to stocks, you would need to decrease your withdrawal percentage even further.
  • Buy “quality” while emphasizing income and dividend growth. Focus on acquiring globally dominant businesses with high returns on invested capital and a long history of dividend growth.
  • Review your calculations every year. This is especially important during your early retirement years. If you're depleting your assets too rapidly, you can make changes to your portfolio, reduce your expenses, or consider going back to work. As you age, your options become more limited.
  • Work as long as you can. Supporting yourself for a retirement that could span 25 or 30 years requires huge sums of money. Consider working at least a couple of years longer than originally planned. Many skills you acquired during your career transition well into consulting or seasonal work. During those years, you can continue to build your retirement assets and delay making withdrawals from those assets. Once you do retire, consider working at least part time to reduce withdrawals from your retirement assets.

1. Stock prices are more volatile than those of other securities. Government and corporate bonds have more moderate short term price fluctuations than stocks but provide lower long term returns. Short term investments seek to maintain a stable value, but returns are generally only slightly above the inflation rate.

2. Withdrawal rate in addition to annual inflation as measured by the consumer price index.