Have you seen the book, “How To Spend the Kids’ Inheritance”? If not, perhaps you've seen the British Airways ads offering “101 Ways to Spend the Kids’ Inheritance.” Both are in the spirit of the old Irish saying, “Only a fool would die solvent.”
Unfortunately, spending to the last penny isn’t easy. And you don't want to run out of money and have to move in with the same kids.
But help is on the way. Indeed, it arrived in the November issue of the Journal of Financial Planning. An article in that issue takes us a big step closer to answering the most common question readers ask: “How much can I spend each year and not run out of money?”
The article’s title isn’t as catchy as “how to spend the kids’ inheritance.” But here it is: “Combining Stochastic Simulations and Actuarial Withdrawals into One Model” by Larry R. Frank, Sr. and Shawn Brayman.
Frank and Brayman aren’t academics. They’re boots-on-the-ground advisers with more than a little math and programming talent. Their research gets us closer to the nasty dilemma presented by retirement spending. It also tells us something most people want to know--- how we can spend more, not less, and still avoid financial ruin.
How much more can we spend? Try this. If you retire at age 60 and are fortunate enough to have accumulated $1 million, the current conventional wisdom says you can spend about $40,000 a year, adjusted for inflation each year, for 30 years. This is OK if $40,000 a year will float your boat. But it also mandates that there is a 95 percent chance that you’ll die with lots of money in the bank, perhaps millions. You won’t come close to spending the kids’ inheritance.
Combine the probabilities of death with the probabilities of portfolio returns and you can start spending at $50,338 a year. That's a 25 percent increase. Better still, your real spending can rise for about 25 years, all based on your ever declining life expectancy.
Think of it as The Dividend of Inevitable Death, a welcome present from the Grim Reaper.
But that added spending comes at a cost. You will have spent the . inheritance. No joke.
Some of this will be familiar to regular readers of this column. I’ve been writing about the “safe withdrawal rate” problem, otherwise known as SWR, for more than twenty years. Work on the puzzle traces to William Bengen, a California financial planner. In 1994 he shook a warning finger at his fellow advisers. He told them that the highest safe withdrawal rate from a retirement portfolio was about 4 percent, not the 5 or 6 percent many were using.
After Bengen, others came up with rules that allowed more spending. Yet these solutions still missed part of the problem--- how long you were likely to live. Having to assume an investment period of 30 years, from 65 to 95 or from 70 to 100, made leaving money on the table almost inevitable. This happened for a simple reason: most of us die before reaching age 95 or 100. And every year of death before 30 years leaves more money behind.
Required minimum distributions provide a rough solution to the problem. Based on a general life expectancy table, we can view RMDs as an early approach to the problem. A study by researchers at the Center for Retirement Research at Boston College, in fact, found that RMDs were a more efficient tool than Bengens' 4 percent rule.
One wrinkle: Most people want or need to make withdrawals before age 70. Frank and Brayman also suggest using income- and-education adjusted life expectancy tables. Remember, there is a five-year life expectancy difference between the top and bottom of the U.S. income distribution.
What does all this mean for you and me?
A new generation of retirement planning/spending tools is on the way. It will help people about to retire plan for higher retirement spending. And it will reduce the fear and dread many have of running out of money.