Contrary to those TV ads by the big mutual fund firms most of us won’t have the $2-3 million in retirement savings when we reach 65. But we can enjoy a retirement that gives us some play money today and protection for our spouse and heirs tomorrow. Here’s how the math works.
Congratulations boomers you made it to retirement. Perhaps you’ve looked forward to this day of no more work, no hellish commute, it’s now time to kickback and let the days drift by. If you’re like most new retirees from the private sector, you most likely don’t have a pension — you have to live off social security and your own IRA savings.
Hopefully, you’ve maxed out your social security contributions during your working years and have delayed taking social security payments so that you have the maximum payout. The good news is that it’s fairly certain you will have those payments for life. There will be a revolution if the federal government tried to cancel social security payments.
Even if you don’t believe you’ll live a long time, you have to consider the financial needs of your surviving spouse. Would you want to leave them destitute because you ‘lived it up’ a little too much during your early retirement and burned through the money? Even though your spouse, at age 66 or greater, is entitled to social security “survivor benefits” at 100% of what you receive, you’re best to assume they’ll live many years after you’re gone, and that will impact your IRA withdrawal strategy.
Living off your IRA presents an interesting math exercise. Just how much money can you pull out each year and not run out of money before you die? Just what is the mathematical equation to figure it out? The missing piece in the equation is: we don’t know how long we’ll live. Is it 15 more years? 25? 30? Who knows? It definitely presents a challenge.
Remember the book, “Die Broke”? The author, Stephen Pollan, advised your net worth should be zero on the last day of your life. In actuality you can’t.
The fact is you may need a hefty balance in your IRA just to pay for end of life. Dying isn’t free, it comes with a price. There’s nursing home care, hospice, funeral, memorial service, etc. Also there can potentially be whopping fees for health care and nursing home care not covered by Medicare. You’ll therefore need a decent balance in your account so your kids aren’t left picking up the tab when you cross to the other side.
Does the 4% Rule Work?
Most financial adviser would advise that you can take 4% out or your retirement account each year forever and the principal will, over time, remain intact. But is that really true? It assumes constant principal appreciation ahead of the income tax you will have to pay (if you’re totally in a Roth, there is no income tax).
Data from the Federal Reserve’s Survey of Consumer Finances for Americans ages 65-74 have an average retirement account of $358,000. Yours may be higher or lower, depending.
Source TheStreet.com:
https://www.thestreet.com/retirement/average-retirement-savings-14881067
So, let’s game play with a retirement savings of the $358,000 for a 65 year old, and using the 4% withdrawal model.
4% x $358,000 = $14,320 a year, or just shy of $1,200 a month.
The theory is that your portfolio will increase by at least 4% a year and you’ll remain at parity. Do you really believe this? As of this writing you can’t get that kind of growth investing in total safety like U.S. Treasuries, the 10 year treasury bonds yield less than 1.70%, far short of the 4% growth. Therefore you’ll need to invest a portion of your IRA portfolio into equities and that means more risk.
There has been a bull market since the great recession bottomed out in 2008, we’re long overdue for major correction and perhaps a full blown recession. You can see why, projecting forward, it may be hard to sustain that assumed growth of 4%.
Hold on, we’re not done with our math exercise yet, Uncle Sam wants a piece of your IRA withdrawals, after all he let you reduce your income taxes when you putting money in. So, let’s reduce that number by a conservative 25% to pay our income tax.
$14,320 x 25% = $3,580.
$14,320 – $3,580 = $10,740 for year one. Or $895 per month net of taxes.
What’s Your New Monthly Nut?
It’s great to play with “income” numbers which are inexact and variable. What’s most likely fixed are your living expenses. Now that you’re no longer working, can you meet those expenses over the next 25 years or further?
In the U.S., on average most retirees live off or $38,000 a year, so there’s a gap between our yearly living expenses and the cash our IRA will yield. Good news, we still need to include our social security payments.
If you worked your entire life and paid into the system, waited until age 65 to begin receiving payments, you could expect a social security check of about $2,500 a month. Again, give Uncle Sam his due of 25% in income taxes, you’ll have $1,875 per month net of tax, or $22,500 a year.
So, let’s add it up:
IRA withdrawal: $10,740 after tax
Social Security: $22,500 after tax
—————–
Total: $33,240 net per year
Not bad, it’s fairly close to that average living expense of about $38,000 a year. You can pay all those lousy bills until the day you die. But, is that all there is? Just get by?
Hold on! What about My “Golden Years”?
We’ve all seen the commercials given by Schwab and Fidelity of this happy grey haired couple walking hand in hand on the beaches of Bora Bora, taking Viking cruise trips up a Norwegian Fiord, and generally globetrotting.
So, what about us! Where’s our winters in the Caribbean and those summer trips to Europe? Where’s our boat? Where’s our RV? Where’s that money going to come from?
O.K., O.K. so the 4% model theoretically leaves your entire principal intact regardless of when you die, be it in 5 years, or 50. But you really don’t need to leave the principal wholly intact, you can start drawing it down at an intelligent rate.
There’s an Exit Fee
As we mentioned our last days on earth can be quite costly and we’ll need a sufficient balance in our savings to pay for our portion of the health care. We’re assuming you don’t want to sell off your hard assets like your house to pay for such.
Hospice terms vary but the median is about 24 days. Medicare will pay for medical services but not occupancy. The average room and board fee is around $320 a day that you’ll need above what Medicare will pay.
Source:
http://www.ssrhospicehome.org/what-is-hospice/what-does-it-cost/
A 90 day stay will most likely cost in excess of $30,000.
Adding it all up to fund a terminal illness, hospice, burial, and estate settlement, you should have a minimum of $60,000 remaining in your savings when you check out. Your spouse will need the same.
The Financial Heartbreak of Alzheimer’s
If you’re fortunate enough to make it to your mid-eighties you would not like the Las Vegas odds of contracting Alzheimer’s. At age 85 about 50% of the population has Alzheimer’s, scary.
Medicare will only pay for up to 100 days of skilled nursing home care under limited circumstances. However, custodial long-term nursing home care is not covered.
The national average cost for nursing home care is about $86,000 a year. .
The average life expectancy after diagnosis of Alzheimer’s is 8-10 years. If we assume the first couple of years the symptoms are mild enough not to require assisted living, one would have to budget for 6 years or $516,000 to get to end of life. And, Medicare’s 100 days of coverage won’t amount to a row of beans.
There are ways for a family member with visiting professional assistance to be the primary caregiver and save money, but that’s material for another post.
But it poses another financial challenge to have that much money in reserve for the possibility of (a) living that long and (b) actually contracting the disease. If you’re fearful you should talk to an estate attorney and perhaps place your assets in trust.
Principal Draw Down Formulas.
For purposes of these exercises, where going to assure there is a minimum $60,000 balance at age 85.
We already discussed that a 4% draw down from your IRA can go in perpetuity. But we want some “play” money.
We’ll assume good asset allocation will continually yield 4% growth. So let’s see what the effect is of increasing our withdrawal rate to a higher rate, say 8%:
| Portfolio Growth of 4% | ||||||
| Age ==> | 65 | 66 | 67 | 75 | 85 | 95 |
| Total Retirement Savings | $ 358,000 | $ 335,088 | $ 313,642 | $ 184,774 | $95,367 | 49,222. |
| Withdrawal @ 8% | $ (28,640) | $(26,807) | $ (25,091) | $ (14,782) | $ (7,629) | (3,938) |
| tax @ 25% | $ (7,160) | $ (6,702) | $ (6,273) | $ (3,695) | $ (1,907) | (984) |
| remaining | $ 322,200 | $ 301,579 | $ 282,278 | $ 166,297 | $ 85,831 | 44,300 |
| Income net of taxes ==> | $ 21,480 | $ 20,105 | $ 18,819 | $ 11,086 | $5,722 | 2,953. |
Although in the early years, the shrinkage in the portfolio is not that dramatic, take a look at the last column should you make it to age 85, you will only have $85,831 in the account. Is that enough to die with? More on this later.
O.K. the 8% is too aggressive. How about we split the difference and go with a 6% draw down, that will look like this:
| Portfolio Growth of 4% | ||||||
| Age ==> | 65 | 66 | 67 | 75 | 85 | 95 |
| Total Retirement Savings | $ 358,000 | $ 344,396 | $ 331,309 | $ 243,015 | $164,962 | $111,979 |
| Withdrawal @ 6% | $ (21,480) | $(20,664) | $ (19,879) | $ (14,581) | $ (9,898) | $(6,719) |
| tax @ 25% | $ (5,370) | $ (5,166) | $ (4,970) | $ (3,645) | $ (2,474) | $(1,680) |
| remaining | $ 331,150 | $ 318,566 | $ 306,461 | $ 224,789 | $ 153,590 | $103,580 |
| Income net of taxes ==> | $ 16,110 | $ 15,498 | $ 14,909 | $ 10,936 | $7,423 | $5,039 |
What’s curious is that by drawing down at 6% vs. 8%, you will actually have more monthly income in the later years. As you can see, at around age 75, the 6% income after taxes ($10,963) is fairly close to the 8% income after taxes ($11,086), and in the ensuing years, it actually surpasses.
In fact, over the entire 20 years of withdrawals, total income after taxes of the 6% is only $15,000 lower than the 8%. Sounds like a winner.
A Last Word about Alzheimer’s
Somewhere around the 6% draw down rate from your retirement savings, augmented with social security, is about right to keep you financially independent through all your senior years. But we’re betting the roulette wheel comes up “red” that we don’t contract Alzheimer’s, what if it comes up “black” and we do get it? How are we going to pay for that extended nursing care?
One could have taken out “long term care” insurance and not have to worry about it. But those policies are very expensive and premiums need to be paid even while you’re retired but healthy thus adding to your annual expenses. An alternate solution is to self-insure.
Self-insuring means you may have to look at liquidating those assets beyond your retirement savings, namely your house. It would have been nice for your kids to inherit it, but life isn’t always nice.
Tweaks
It gets a little scary working these formulas but there are other things you can do:
Wait to draw social security until you’re 70 instead of 62, it could add $12,000 per year income. Again think about the welfare of your surviving spouse.
Keep a part-time job, see our post The Paradox of Semi-Retirement. Imagine you can run a small business or find a part-time job to meet all your expenses and you did both of these: waited until age 70 to start social security and waited until age 75 to go to a full stop work retirement, here’s what that scenario would look like.
| Portfolio Growth of 4% | ||||||
| Age ==> | 65 | 66 | 67 | 75 | 85 | 95 |
| Total Retirement Savings | $ 358,000 | $ 372,320 | $ 387,213 | $ 529,927 | $206,362 | 80,361 |
| Withdrawal @ 10% | $ | $ (52,993) | $ (20,636) | (8,036) | ||
| tax @ 25% | $ | $ | $ (13,248) | $ (5,159) | (2,009) | |
| remaining | $ 358,000 | $ 372,320 | $ 387,213 | $ 463,687 | $ 180,567 | 70,316 |
| Income net of taxes ==> | $ | $ | $ 39,745 | $15,477 | 6,027 |
In this case, you can actually withdraw at a higher clip of 10% to end up with a balance at age 85 higher than our 6% example above but have a lot of play money in that decade. Just a thought
Premeditatio Malorum
The stoics have a philosophy of premeditation of the evils, or imagining all the things that can go wrong, not to be a paranoiac, but ensuring nothing takes us by surprise. It’s the unexpectedness that adds weight to the disaster.
As you journey to your end at least you have both eyes wide open as to the multitude of scenarios that can take place. And with your appropriate actions your spouse and heirs won’t get burned. Let’s hope for the outcome in Kenny Roger’s song:
“And the best you can hope for is die in your sleep.