How Much Can Retirees Spend On March 11, 2020? It May Not Be What You Think

Turbulent market volatility and declining
interest rates are leaving many people wondering about the viability of their
retirement plans. Given where markets are today, will you have enough to meet
your retirement spending goals?

Attention often turns to the 4% rule, which is a simple rule-of-thumb to guide retirement spending. It is the highest withdrawal rate that would have worked with historical U.S. market returns for someone adjusting their spending for inflation each year and planning for a 30-year retirement. It is important to understand that the 4% rule does not apply today, as retirees face the lowest interest rate environment we have ever seen. It also was never meant to apply for those who were not willing to hold at least 50% stocks throughout their retirements.

In this column, I’ll describe my estimates for
sustainable retirement spending in the current market environment. My estimates
for a spending strategy matching the “4% rule” assumptions will be lower, but
I’ll also discuss ways to get spending up to a higher number. This can give
hope to those who are panicked about the stock market and interest rates. These
estimates are for a couple who both turned 65 on March 10, 2020, in order to
give a sense of what things look like for today’s retirees.

The following summary is necessarily brief and
for those seeking greater details, I have written books on these topics. The
general story of spending from investments as well as how I create these
simulations is covered in my book, How
Much Can I Spend in Retirement?
power of risk pooling and annuities to compete with the stock market is the
topic of Safety-First
Retirement Planning
, and you can learn more about reverse
mortgages in Reverse
Mortgages (2nd Ed.)

Before turning to the volatile investment
portfolios assumed by the 4% rule, we start the story with dedicated income
sources. These include building a bond ladder by holding individual bonds to
maturity to support retirement expenses, or purchasing a simple income annuity
that turns a single premium into protected lifetime income.

Click here to download our resource, Why Investing During Retirement Is Different.

For bonds, we look to building income to support
30-years of retirement spending. Spending rates that work with the full range
of available bonds end up matching closely with what the Treasury Department
reports as the composite long-term Treasury bond interest rate. As of March 10,
2020, these interest were 1.27% for traditional bonds and 0.12% for Treasury
Inflation Protected Securities (TIPS), which support inflation-adjusted

We consider three spending goals over 30 years:
Fixed spending that does not grow for inflation, spending that automatically
grows each year at 2% as an approximation for inflation, and spending that
grows for the actual inflation experience as defined by the Consumer Price
Index (CPI). About the assumed 2% spending growth, this used to match what
markets expected inflation to be over the long term, though with the March 10
interest rates, the breakeven between the interest rates is only 1.15% (1.27% –
0.12%). It seems that inflation would not stay that low over the long-term so I
will keep the 2% cost-of-living adjustment with the second spending strategy.
This explains why I show a lower spending rate than when assuming actual CPI
adjustments. These spending numbers are 3.98% for fixed spending, 3% for a 2%
COLA, and 3.39% assuming the bond ladder is created with TIPS. The disadvantage
with these bond ladders is that they will ensure all assets are depleted at the
end of 30 years.

This table also shows single-premium immediate
annuity payout rates. These numbers were collected on March 11 and show the
average payout from the top three quotes at These
quotes are for a couple and provide joint lifetime income at the same level as
long as at least one member of the couple is still alive. These quotes are
life-only, meaning that beneficiaries do not have the opportunity to receive
something in the event that both members of the couple end up not living long.
These payout rates are higher, with 4.98% on fixed spending and 3.8% with a 2%
cost-of-living adjustment. In the past, some insurance companies provided a
CPI-adjusted SPIA, but currently none are available on the market. These
numbers are higher than with bonds because annuities allow for risk pooling.
The premiums from those who end up not living as long help to support the
payments to those who live longer. Retirees can pool their longevity risk
instead of trying to self-manage this risk by assuming they may live longer
than average (such as for 30 years to age 95).

 (1) Sustainable Spending from Dedicated
Income Sources

Spending Rates Obtainable for 65-Year Old Couple March 11, 2020

Next, I estimate sustainable spending rates with
specified allowances for retirement risk using volatile investment portfolios
(stock and bond funds). These strategies have greater downside risk which is
why the sustainable spending rate can potentially be less than found with
dedicated income. By investing in stocks, retirees hope for greater spending
power through market growth, but they have to spend conservatively to
self-manage both the longevity risk and the risk that markets do not cooperate
and returns are low. If markets do fine, these strategies also have greater
upside growth potential to allow for more future spending or to provide a
greater legacy.

Spending numbers are divided between conservative,
moderate, and aggressive retirees. I define these retirees based on their
willingness to invest in stocks (25%, 50%, or 75% stock allocations), and their
willingness to see their portfolio decline to low levels (see the table notes).

The table is divided into three parts. First are
the spending strategies that are comparable to the dedicated income strategies
shown before. We can observe that conservative and moderate retirees would need
to spend less in order to maintain sufficient confidence that their wealth
doesn’t fall by too much, but that aggressive retirees could spend more by
taking on greater risk that the plan won’t actually work. Nonetheless, the 4%
rule is not applying to the inflation-adjusted spending. For a moderate
retiree, 2.4% is the comparable number today. I assume the simulations start
from today’s lower interest rates and that stocks outperform bonds by their
average amount historically along with their historical volatility. Since 1926,
large-capitalization U.S. stocks outperformed long-term government bonds on
average by 6% per year with 20% volatility.

(2) Sustainable Spending from Volatile
Investment Portfolios

Spending Rates from an Investment Portfolio March 11, 2020

These numbers can look bleak, but not all is
lost for today’s retirees. Let’s consider three possible ways to spend more.

The first is with buffer assets. These are
assets available outside the financial portfolio to draw from after a market
downturn. Returns on these assets should not be correlated with the financial
portfolio, since the purpose of these buffer assets is to support spending when
the portfolio is otherwise down. The two main buffer assets are to use policy
loans with the cash value of whole life insurance (though this would have to
have been set up years in advance), or to open a line of credit with a reverse
mortgage. By helping to reduce the need to take distributions from the
portfolio when it is in trouble, buffer assets can support a higher spending
rate with the same level of sustainability. I include spending rates from the
investments assuming a buffer asset holding five-years worth of spending power,
and that spending is sourced to the buffer asset in any year that the remaining
portfolio balance fell below its initial level at the start of retirement. For
moderate retirees, the buffer asset raised the spending rate from 2.88% to
3.56% for spending with the fixed cost-of-living adjustment, and from 2.4% to
2.91% for inflation-adjusted spending.

The next way to spend more is to use a variable
spending strategy. Spending can start higher, but only because there is a
built-in willingness to cut spending as necessary. There are many possible
variable spending strategies. I include the Guyton and Klinger decision rules
in the table because they are probably the most famous. This strategy assumes
inflation-adjusted spending, but the inflation adjustment is skipped in years
after the portfolio experiences a loss, and spending is further cut by 10%
permanently at any point in the first 15 years of retirement that the
withdrawal rate from remaining assets has risen more than 20% above its initial
level due to a declining portfolio balance. In a bad market, there could be
several of these permanent 10% spending cuts. In the other direction, spending
can also increase by 10% whenever the portfolio grows sufficiently so that the
current withdrawal rate is more than 10% lower from where it started. These
rules are complicated and will require careful monitoring with a spreadsheet,
but we can see this is another way to preserve spending and the “4% rule”
survives in the moderate case.

Finally, we could consider a case that
integrates insurance and investments. To be consistent, let’s suppose a
spending goal with 2% spending growth throughout retirement. Using only
investments, a moderate couple would be looking at a 2.88% spending
rate. Suppose they place 30% of their assets into a SPIA. It offers a 3.8%
withdrawal rate. Also, because they now have this downside protection for their
spending, they start to relax more about market volatility and feel that they
can behave more aggressively with their remaining investments. That moves them
to a 3.97% withdrawal rate. Blending the annuity and the investments, their
combined withdrawal rate increased from 2.88% to 3.92%. Because bonds are
really the least efficient way to support retirement spending, this type of
integrated strategy would work even better for conservative retirees. And while
I considered SPIAs here, there are other available annuity options that
preserve liquidity and upside such as variable or indexed annuities that
include a protected lifetime income benefit.

And so, things look bleak, but there is a path
forward. Buy incorporating partial annuity use, having access to a buffer
asset, and having some capacity to reduce spending, a reasonable withdrawal
rate can still be possible and can provide some relief to those approaching
retirement at this unprecedented time.


Originally posted at

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