Q. In your article, "retiring isn't just about money", you write, "as a rough rule of thumb, you can think about taking 4 percent from your financial assets every year." I have heard that same statement several times but am not sure exactly what it means. Can you clarify?
If someone has financial assets of $300,000 (for simplicity, assume all in bank CDs), would your comments suggest taking 4 percent of the $300,000 ($12,000) every year, plus whatever interest is accumulated, until the account was depleted? Or would you take 4 percent of the account balance in every year? —P.O., from Seattle, WA
A. The 4 percent rule of thumb has a long history and references the annual rate of withdrawal from a nest egg. Schools and charitable institutions, for instance, have long been advised that they should limit withdrawals from their endowments to 4 or 5 percent of principal a year. For individuals and couples financial planners have come to the same figure by a different method, but it starts with 4 percent of your original nest egg. After that, your annual withdrawal is increased by the rate of inflation each year, regardless of the ups and downs of the nest egg.
In other words, if you have $300,000 in retirement savings, your withdrawal should be about $12,000 in the first year. If inflation is 2 percent during that year, your withdrawal should be about $12,240 in the second year. Repeat the process year by year. Withdrawals done in this manner from a balanced portfolio of equities and fixed income have been shown to deliver a high probability of not running out of money during a retirement period of 30 years.
The caution here is that most of the time periods covered by portfolio survival studies have been during periods when both interest and dividend yields were significantly higher. Today’s lower yields suggest that survival odds for portfolios that are 50 to 75 percent equities will decline. A portfolio that was 100 percent fixed income with the same withdrawal scheme would not survive. You can learn more about “portfolio survival” by visiting my website and checking the topic by that name.
Q. My age is 70. My wife is 65. Both of us are on Social Security. The pre-tax amount for both of us is $39,576. We have the following invested with a portfolio manager: a joint account with $108,000, my IRA with $255,900 (I took the first distribution this month.), my wife's IRA of $149,607 and cash of about $180,000. Our home is worth about $275,000 with mortgage balance $136,600 at 4.70 percent and 29 years to maturity. The payments are $725 a month. Our monthly expenses run about $5,500 per month. We are considering retiring this year.
I have two questions. First, should I pay off the mortgage? Second, can we afford to retire? —L.F., from Lakeway, TX
A. There’s no slam dunk here. You’ve got a lot of fine pencil work ahead of you. Why? Because however you slice it, it will be a close race between your spending and your total income.
Paying off the mortgage will reduce your cash income needs by $8,700 a year. This will make it easier for your remaining assets and Social Security to cover your monthly expenses. Since you are now 70, not 62 or 65, it is somewhat more reasonable for you to plan an annual withdrawal rate of about 5 percent from your financial assets.
Mind you, I said “somewhat.” In the current environment it would be better for you to keep your withdrawal rate to about 4 percent— very close to your RMD level. If you paid off the mortgage and withdrew at 4 percent from the $557,000 of remaining financial assets, your total income would be about $62,000. Your total expenses would be about $57,000. There’s not a lot of wiggle room there, even with a very low income tax bill.
One factor moving in your favor— aging. Consumer spending tends to decline after age 55, even more than healthcare expenses rise.