Monday, October 14, 2013

Retirement - Your Second First Job (4)


You have been saving, investing and growing your retirement portfolio during your working career.  As a retiree, you should now think like the British and focus on income.  The amount of income you need in retirement is dictated by your desired lifestyle.  How much will you need in order to do what you want for the remainder of your life?  You should start with a budget and see how your retirement income matches how you want to live.  If you have enough to "live the dream", great!  If your income falls short and you do not want to continue to work in some capacity, you have two choices: change your lifestyle or change your income level.  You need to decide how you will handle your retirement assets to support your retirement and not run out of money.  Answering that key question is your Second First Job. 

In the 1990s, William Bengen, a certified financial planner, studied this issue.  He made three assumptions, i.e., the portfolio was in an Individual Retirement Account (IRA) or other tax-deferred account; the retiree did not intend to leave any inheritance, and the savings had to last for thirty years.  Based on those premises, he determined that a retiree would not outlive his or her savings if withdrawals were limited to 4% of the account valued annually.

As with all other financial research and rules, not everyone agrees with Bengen's 4% rule.  Some look to the condition of the market at the time of retirement as a factor.  If the market is down or in danger of decline in the near future when you leave the work force, 4% may be too much to take out early in retirement.  If the market is rising and a retiree has a high risk tolerance (severe stock market fluctuations do not bother the individual), the rate might be set higher than 4%.  Like asset allocation rules, deciding on a rate of withdrawal is not a one time decision.  Both asset allocation and withdrawal rates should be revisited annually.  You might consider the 4% rule as a starting point for your first year of retirement.

Let's review your $800,000 combined hypothetical and cash portfolio from the last post.  As you may recall, we arrived at a notional value for your Social Security benefits of $400,000 (based on a 3% interest rate generating a $12,000 annual payment) and a cash IRA of $400,000.  The cash IRA was divided into debt securities worth $120,000 and the balance, $280,000, was invested in stocks or mutual funds.  Counting the Social Security payments as a debt security gives you a 65/35 percent allocation between your notional and actual debt assets and your equity assets (the age based allocation rule).  Using the 4% rule, this means that you can withdraw 4% of your $800,000 portfolio ($32,000) annually with the goal of your assets lasting 30 more years.  You are receiving $12,000, which is 3% of the $400,000 hypothetical value of your Social Security account.  In order to average 4%, this means that you might withdraw up to 5% of your $400,000 cash IRA.  Your retirement income of $32,000 would consist of the Social Security payments of $12,000 plus $20,000 (5% of $400,000) from your cash IRA.  Obviously, you would want to first withdraw the interest and dividends generated in your IRA to preserve principal.  If that is not enough, the balance would have to come from your principal.

The hope is that your equity holdings will appreciate at a rate greater than your withdrawal rate so your portfolio either remains the same or increases.  Another way to handle this might be to take out only the income generated by your portfolio.  In all probability, you would be taking out less than 4% from the total portfolio.  Conversely, you could increase your withdrawal rate to maintain your standard of living.  Keep in mind that with a higher withdrawal rate, your savings may not last as long as needed.  You might allocate more assets to equities for a potentially higher yearly return, but this would expose your portfolio to a greater degree of market risk.  To sustain a desired life style, you might make a greater equity allocation, a higher withdrawal rate or both.  You would have to decide if you can comfortably accept greater market risk.  What is your risk tolerance?

Decisions, decisions: yes, this is your Second First Job.

Comments are always welcome.

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