February 23, 2010 in Business

Plan your retirement for life’s surprises

John Schram
 

Q: I have heard that if I only spend 4 percent of my retirement savings yearly I will never run out of money and it could possibly even grow. Sounds like a prudent strategy. What do you think? – JK

A: I think that rules of thumb such as the 4 percent rule should be applied with great care. The assumptions built into it typically boil down to a simple set of considerations, which go something like this:

If I can invest in an income with moderate growth portfolio and earn an average 7 percent per year, taking 4 percent still leaves me enough to grow the account by 3 percent and keep pace with inflation for the subsequent withdrawal. I can still die with more than I started with due to the 3 percent annual growth.

This scenario does not consider that rates of return are seldom constant, inflation always seem to spike at the wrong time, and your need for income does not decrease by 25 percent just because your portfolio is down by 25 percent. Those of us who prefer to not run out of money before we die should consider additional factors.

•How much retirement income will come from guaranteed sources such as pensions, annuities or social security? The greater your percentage of overall guaranteed income, the better.

•Will any guaranteed source of income keep pace with your inflation let alone someone else’s ever-changing definition? Your portfolio will have to do double time if not.

•How long will you live? I would not want to bet my retirement lifestyle that living to age 100 was out of the question. Average lifespan means many people live a lot longer.

•Are you able to adjust spending significantly enough to allow for any decreased portfolio values to recover? This assumes that you have a buffer in the size of your portfolio or that you have plenty of discretionary spending.

•Are you able to consistently stay invested? A 3 percent certificate of deposit or bond coupon may be part of a prudent plan but may not allow you to consistently keep pace with your inflation.

Finally, I would be remiss if I did not point out the elephant in the room. Do you really know what your actual expenses are in retirement, and do your actual expenses take into account periodic large purchases, such as vehicles, vacations or a new roof?

Many who may have been able to make their portfolio last by drawing only 4 percent are now on a steep decline due to too many of these one-time expenditures eating away at their ability to produce income. Financial planners typically have sophisticated tools which can project out a multitude of future scenarios. Our office calls this the “40 Factor” analysis. By no means does this guarantee success, but it provides a basis for decision making that leads to a higher probability than just a rule of thumb.

John A. Schram is a certified financial planner and member of the local Financial Planning Association chapter. Readers are invited to submit questions on financial planning to be answered in this space each Tuesday. Send questions to askaplanner@ spokesman.com.


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