In my last blog I discussed how the Covid pandemic along with other factors caused many people to rethink how they would be working, and how long they would be working.
In the past decade, about 2 million baby boomers per year retired. In 2020 there was a 50% increase in that figure with over 3 million people retired that year. Of course, not all these people made the retirement decision voluntarily as some people were downsized either before or during the pandemic.
One of the first challenges in distribution planning is dealing with longevity risk. Joseph Coughlin, head of the MIT Age Lab, reported that there were 43 million people in the United States age 65 and older in 2012. (Please see my October 2019 Newsletter for a description of my time at the MIT Age Lab.) By 2030 around 73 million people will be 65 and older. That represents a jump from about 13% of the US population to more than 20% of the US population. Most of the financial planning software in our industry uses the fault life expectancies of age 94 for female clients in age 92 for male clients. We at New England Capital typically use a 30-year retirement timeframe which could span from 65 to age 95. In fact, by the year 2050 it’s estimated that more than 3.6 million people will be older than 100 years old according to the Pew Institute.
This longevity risk poses one threat to the 4% rule, a long-held rule of thumb in the financial planning industry. The 4% rule is based on research by financial planner William Bengen, CFP. He wanted to know what the safest maximum withdrawal rate would be for his clients assuming a 30-year retirement timeframe. His research started with data from 1926 and showed that you could take a 4% distribution and increase it annually based upon inflation and not run out of money in the 30-year retirement. His research has been peer tested continuously since he first reported his findings in 1994. We have tested it during deflationary times and inflationary times and it holds true.
The other threat to the 4% rule is based upon the low bond yields and higher stock valuations that we’ve had over the past few years. Some of this risk has been reduced as bond yields have increased due the Federal Reserve increasing rates to combat inflation, and the recent decline in the stock market valuations this year.
I still believe that we can use the 4% rule as a starting point and maybe even increase that if a client’s spending needs could be flexible. Taking less money from your accounts during market declines would allow for taking more during times of market increases. Asset allocation of the retirees portfolio is crucial to maintaining the 4% distribution rate. We feel rebalancing the portfolio annually will also add to the viability of the distributions during retirement. As a matter of fact, financial advisor Michael Kitces feels the maximum distribution rate could actually be increased to 4 1/2% in most situations. The real key, we feel, is to continually monitor your portfolios and your situation to assist you in your goal of never running out of money during your lifetime, but also not being too frugal. We don’t want you to “leave too much on the table” and not enjoy the withdrawals from your accounts that could add to your enjoyment and lifestyle.
As always, we are ready to talk with you about your situation to help you achieve your life goals.
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