To Spend Down, Or Not To Spend Down: That Is the Question
May 07, 2014

To Spend Down, Or Not To Spend Down: That Is the Question

Q. My husband is 67 years old. I am 64. He would like to retire this year, but we have conflicting ideas about "spending down your principal" which you have mentioned several times in your columns. My husband believes we can comfortably spend down our savings because we are not likely to be alive in 30 years.

My mother is 97 and still drives. She lives alone in a small town. I feel that, no matter how much money you have, you have no idea how long you are going to live. And with medicine and longevity improving, how can anyone guess how long they are going to live? My mother is grateful she has not spent her modest savings. She might need it, she says, for going into assisted living.

She is fully aware of her finances and I am grateful that the idea of spending down her principal was not in her vocabulary. She has always lived on her interest. She has kept her modest savings intact for 27 years. And she is comforted by the fact that she will not be on Medicaid in the near future.

I do not think anyone can assume that they will not be in that 1 percent that lives to 98. ?I believe you need to keep your savings intact, because you have no guarantee that you won't be alive in 35 years. You should only live on Social Security and the income your investments generate. If this income does not meet your necessities, then, out of necessity, you must spend down your principal.

Tables tell a story, but no one knows where they will be on that table. But spending down your principal with the idea you are not going to make it another 30-35 years should not be a consideration. Many of us could be left without money at the age of 95, if we assume we won't be alive and that we can spend down our principal.?My husband thinks that we should take that risk. I am in complete disagreement with him. ?—J.S., A concerned reader in Illinois? ?

A. As a practical matter, it isn’t possible to live on interest and dividends alone. Eventually, almost everyone has to spend some principal. There are two reasons for this and we can’t do anything about either.

First, current yields on savings and on common stock shares are very low. Most people hope to meet their expenses if their savings earn an average of 5 or 6 percent. But today it’s difficult to earn much over 2 percent. Thankfully, this isn’t normal and we may someday see interest rates and stock yields that are closer to historical averages.

Second, most people have the bulk of their savings in tax deferred accounts that are regulated by government. The rules call for a minimum distribution requirement when you reach age 70 1/2. The distribution rate starts at 3.65 percent. That’s already more than most accounts generate in current income. From there the distribution rate increases each year. It reaches 5.35 percent at age 80; 6.76 percent by age 85; and 8.77 percent at age 90. However your money is invested, at some point you will be withdrawing principal.

You may, of course, elect to save some of that distributed principal. But it will become very difficult since you’ll have to pay taxes on every dollar withdrawn. What this means is very simple: All of us are committed, by law, to spend some amount of principal. All we can do is try to do it intelligently.

You may also have some savings in a taxable account. If so, you have no need to make minimum required distributions. Indeed, you might even reinvest all after-tax income. But unless you are very wealthy, most people will have to choose between deprivation today and possible deprivation tomorrow.

All of this, by the way, is another reason that homeownership is so important. The equity in your debt-free home can be regarded as your deep reserve. You may never need to access it, by sale or reverse mortgage, but it can be there as a last resort if your path for spending down has been too deep. It’s also a reason that the purchase of life annuities can be a very useful tool— they can increase current incomes and guarantee that you will have income for the rest of your life.

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