Life: How Much Will You Leave On the Table?
April 06, 2012

Life: How Much Will You Leave On the Table?

Measuring the Yield Famine in Food

How would you like to double your retirement spending?

Well, Michael Finke is working on just that. He thinks we may be able to live better in retirement than most professionals have thought for nearly two decades. The Texas Tech University associate professor, along with two other researchers, Wade D. Pfau and Duncan Williams, has examined William Bengen’s well-known 4 percent safe spending rule and found that some retirees, perhaps many, can spend a lot higher on the hog. Simply raising the spending rate to 6 percent means you can spend 50 percent more.

“By emphasizing a portfolio’s ability to withstand a 30 or 40 year retirement,” the researchers write in the March issue of the Journal of Financial Planning, “we ignore the fact that at age 65 the probability of either spouse being alive at age 95 is only 18 percent.” As I pointed out in a recent column, it’s silly to have 95 percent confidence in your income when your chance of being alive is much smaller.

Excessive caution, he told me in a recent interview, means we buy long-term security at the expense of giving up many things we’d like to do today. We leave estates that are larger than planned and feel remorse for experiences we’ve missed.

So the researchers reframed the dilemma. Putting investment results in the framework of our life expectancies, they asked this question: If you withdrew at a greater rate, what percentage of your remaining years of life at age 65 would you be broke?

While most people would not want to risk going broke early in retirement they might feel differently about going broke at 85 or 90 if it would change their life in the intervening years. Here is what they found for a couple where both are retiring at the same age, 65.

  • At a 4 percent withdrawal rate the couple was virtually certain to avoid going broke with a portfolio that ranged from 30 percent equities to 60 percent equities. Even with less, or more, equities, they were likely to spend less than 2 percent of their remaining years of life without wealth.
  • At a 6 percent withdrawal rate the risk of going broke increased, but a typical balanced portfolio of 60 percent equities, 40 percent fixed-income securities reduced the percentage of years without wealth to about 7.5 percent of expectancy. In other words, they could spend 50 percent more for 92.5 percent of their remaining lives by accepting the risk of living in reduced circumstances for the remaining 7.5 percent.
  • At a 7 percent withdrawal rate the risk of going broke rose further, to about 14 percent of remaining years of life— if their portfolio was 70 percent equities. For other allocations, up or down, the risk was somewhat higher.
  • At an 8 percent withdrawal rate— a rate few financial planners would suggest— the couple would face living 20 percent of their remaining life without wealth if their portfolio were 90 percent equities. Note that as the withdrawal rate has increased, the optimal portfolio allocation has also increased. A retirement portfolio that is 90 percent equities is a real “swing for the fences” portfolio.

Recall that the joint life expectancy of a 65-year-old couple is about 25 years. So we’re talking about living better for a lot more years than they would be living at a lower standard. The 8 percent withdrawal couple, for instance, could enjoy 20 years of doubled spending at the expense of 5 years of being broke, starting at age 85. Since we tend to reduce spending as we age, the loss of wealth and income could be less of a hardship than it might seem.

The researchers caution that since women live longer than men, more of the risk burden would fall on women. That may be an understatement. In a 65-year old couple the first death is likely to occur at 15 years, leaving the surviving spouse another 10 years of life. A thoughtless husband could suggest a 9 percent withdrawal rate, knowing they’d spend well while he was alive and the lean years would fall on his widow.

The researchers also considered another factor— assured income. If retirees have a “floor” income for their lifetimes from a combination of Social Security, pension and life annuities, they can think about running out of wealth before death with less worry than if their only lifetime income is from Social Security.

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