Thursday, June 30, 2016

What happens to retirees when the money runs out?


A Maryland couple is finding that out the hard way.

We never expected to live this long. My parents died when they were in their 70s. My brother was 62 when he passed away. My wife's father died while she was still a little girl. I believe her mother was in her 70s when she died. And my wife's big sister was a teen-ager when she died. And yet, my wife and I are still standing.

We did plan for our retirement. We paid off the mortgage on our 1950s rancher to guarantee that we'd have a roof over our heads no matter what. And, while I was still working in the small business I had founded, I stashed away a couple hundred thousand dollars in some relatively safe investments. I was confident that with just a six percent average return on our investments, plus our combined Social Security benefits, and memberships for both of us in Medicare and supplemental health care insurance policies, ours was a fail-safe plan. Man, was I ever wrong. Ten years and about a $100,000 dollars wrong.

Things haven't quite worked out as planned. A number of substantial reversals in the stock market, coupled with unanticipated departures of several major clients from my business proved disastrous. Less business. Less income. No fail-safe retirement. We now have no income other than our Social Security benefits. Interest paid on our severely depleted "savings" is practically non-existent.

We now have to deal with the ever-growing problem of stretching our dwindling retirement plan resources and Social Security benefits to maintain an acceptable lifestyle and standard of living. This surely won't be easy.

There's more at the link.

This is going to be an increasingly common experience as retirees live longer, and as the rate of return on investments steadily shrinks.  At present, thanks to zero interest rate policies and other official measures, that rate has been reduced far below historical averages - and there's no sign of improvement in the short to medium term.

Since the 1990's the so-called '4% Drawdown Rule' has dominated US retirement planning.  However, under the impact of the 2007/08 financial crisis and its aftermath, that may no longer be good enough.  In a recent analysis of retirement planning, the New York Times reported:

In a recent analysis, Mr. Pfau compared several withdrawal strategies in an attempt to illustrate how spending patterns might change to guarantee that a portfolio will last for 30 years, even if low rates persist or retires face some other awful combination of events.

He found that people who spend a constant amount adjusted for inflation — similar to the 4 percent rule — would have to reduce that rate to 2.85 to 3 percent if they wanted assurance that their spending would never have to dip below 1.5 percent of their initial portfolio (in inflation-adjusted terms).

So a retiree with $1 million could securely spend nearly $30,000 annually for 30 years, in the best and worst of market conditions. The big drawback, though, is that if economic conditions are generally average, retirees would be left with $794,000 in unspent money. If they were unlucky and experienced terrible market conditions, they would be left with $17,900.

That’s the trouble with this strategy. “Most of the time, you underspend,” said Mr. Pfau, who is also a principal at McLean Asset Management. “Yet you still run the risk of running out.”

Again, more at the link.

There's also the real danger that Social Security payments - on which many plan to depend for a significant proportion of their retirement income - may be so drastically reduced in purchasing power terms (due to not increasing in line with the real, as opposed to 'official', rate of inflation), that they may no longer be adequate.  Some even believe the entire Social Security system may become bankrupt, and its payments be suspended indefinitely.  I don't know about that, but given lower payments (in real purchasing power terms), we'll be more and more dependent on our own savings for retirement - and most Americans don't have much saved at all.  What's more, increasing medical costs may bankrupt Medicare and Medicaid, so that the relatively low-cost medical care anticipated by many approaching retirement simply won't be there.  They'll have to fund such expenses themselves to an ever-increasing extent.

Look at it this way.  If you expect to need $30,000 per year in retirement income, over and above Social Security payouts, and if you accept as valid the 2.85% annual withdrawal rate mentioned in the New York Times article above, that means you'll have to have saved over a million dollars by the time you retire.  That's a frightening figure . . . and you'll need more than that if you survive for 35, or 40, or 45 years, which is entirely possible given modern medicine.  I doubt whether many Americans have even a tenth of that sum saved for retirement!  I certainly don't.

There's also no guarantee you'll be able to sell your expensive home for as much as you expect, and use some of that money to fund your retirement.  We've discussed that in these pages before, most recently earlier this month.  Non-liquid assets are worth only as much as someone is prepared to pay for them - or as much as they're able to finance through the banks.  If no-one can afford the asking price, or no mortgage is available, sellers are as badly hurt as buyers - as are, in this case, the former's retirement plans.

Food for thought . . .

Peter

19 comments:

Jason said...

The article doesn't mention the oldest retirement strategy: children. I have to wonder if the couple decided against having children on the assumption that other people would produce the future taxpayers who'd fund their retirements for them.

As one of those taxpayers, my sympathy is limited.

tweell said...

All you can do is all you can do. Our government has been lowering interest rates to make their borrowing cheaper and printing money in order to keep spending. That hurts those folks living off of investment income and fixed incomes worst. A six percent return hasn't been available for quite a while now.

Seeing that their business is basically gone, I'd sell that house and move if I was them. Housing is doing okay right now, helped along by the same factors that are killing their investment income. Maryland is an expensive state to live in, go where it's cheaper.

A backup plan of mine is to set up an old work van as a mini-RV. I'll get a chain gym membership for hygiene purposes if I'm in civilization, or just stock up and go camping. You can live cheap if you aren't paying for property (and you always pay, mortgage or not), just ask any homeless guy.

WhatIfWeAllCared? said...

Living below poverty level working 48+ hrs/wk I do not have retirement savings. I will be either doing a live aboard or living out in the woods. Not sure medical is even relevant any longer as the obamacare has cut most services I had access to. Learning to only rely on God, my son (autistic) and myself.

Anonymous said...

No plan, other than significant wealth, will survive the sinking ship.

In everyone's zeal to destroy industry along with unions they have destroyed middle-class finance. Whole industries declaring bankrupcy to shed retirement plans and our foolish insistance on self-funded retirement will leave most people with little other than SS.

But hey, it sure makes it easy to afford that house/boat/rv/vacation today.

Anonymous said...

And if you have an IRA, the Feds demand that you withdraw enough that it is gone by the time you are 85. You don't have to spend it, you just have to clean the IRA out by putting it into regular accounts, other investments, or what have you. Which are taxable.

LittleRed1

Judy said...

As a member of the working poor for 40 odd years before retiring. What savings? I would love to see those economic geniuses take the wages I earned, build that million dollar cushion for retirement and raise a family at the same time.

Anachronda said...

When I was a kid, *everything* caused cancer. My retirement plan, ever since then, was to die of cancer before age 50.

Reality did not accord with expectations.

Greybeard said...

Retirement?
It's a relatively new concept.
Work.
Sure, you won't make a fortune, but it will more than cover expenses.
(Or stand on a corner with a sign and earn $35000+ per year.)
What a world.

Old NFO said...

Staring that in the face now...sigh

Will said...

As Jason mentions, it used to be that children were the retirement system. Well, that stopped for a lot of baby boomers, due mostly to the high taxes the Progressives foisted on us to pay for all the social systems that socialism demands on it's way to destroying nations. That lack of children is the killer. Built into the system, and can't be avoided, when it takes two incomes to support a so-called family.

You may, I repeat MAY, extend the life of a nation by importing the dregs of the rest of the world, but it seems pretty clear that it is not a good way to attempt it. Not efficient, very painful, and the end result will please no one involved, including those so-called Elites.

The Greatest Generation was anything but. They thought they won the war, but that was merely a battle along the way to actually losing the real conflict. They not only took their eye off the ball, they walked off the court. We're left with making rear-guard attacks, in the attempt to slow down the collapse.

Quartermaster said...

The situation we have now was predicted 30 years ago. There was no way that returns would ever be sufficient to fund retirement at the levels financial planners were telling us. With the boomers owning stocks, then selling them into a market where many boomers were doing the same thing was also a fool's bet.

"Rich dad" told Kiyusaki that the system was bound to fail. We're seeing the first stages now.

Anonymous said...

What is this "Retire" you speak of? I have 18 years in and am 45. I'll have 30 when I'm 57. I don't plan to retire until the federally mandated 67, and even then I'll be doing what my father did and working a small job for the extra money and medical benefits. I don't plan on using my full retirement bennies until I'm literally too sick to work.

Anonymous said...

I believe there are numerous holes in this story, and submit that perhaps you are drawing an overly pessimistic conclusion. My reasoning:
• I feel like I was denied critical, need-to-know information. More information would allow us to properly evaluate the Seymour’s retirement strategy, such as their spending per year, nature of their investments and business failures, etc… I suspect if these details were known, the flaws in their retirement “plans” would become apparent.
• What he describes is not a retirement plan; it is at best an entity which superficially resembles a plan. A plan would require that he balance his requirements with his resources and have a reasonable expectation of success. What he did is throw some money in an account and call it good. He likely also made some poor decisions, perhaps panic selling during a downturn, but that is pure speculation.
• The fact that he describes selling their home as a “non-starter” suggests that he is not making decisions based on their financial sense, but based on emotion. He queries “Why sell our home to live in someone else’s apartment?” The answer is simple: Because you might be able to afford the apartment, but not the house. Making it a “non-starter” keeps him from looking seriously at a potential solution.
• There seems a misconception that once you are “retired” you are entitled to never think about money again. Why? If nothing else, you should treat your personal finances as a part-time job. Adjustments will surely be required based on actual conditions.
• Why would you structure your retirement to only last x years? The difference in required assets to last 30 years and indefinitely is surprisingly small. Do you want to end up broke? Because that is how you end up broke.
• The 4% safe withdrawal rate (SWR) is simply a rule of thumb, not a law of nature. Wade Pfau is also the one who invented it, google Trinity Study. It is, however, only a rule of thumb, and you are absolutely welcome to choose a more conservative SWR as a “safety margin”. It appears that Pfau himself is suggesting 3% or slightly less based on the article you linked. This seems excessively conservative to me, but I am apparently an incurable optimist (this will be news to my wife, I assure you).
• Speaking of safety margins, you should have them built into your strategy. I am an engineer; I would be a colossal moron if I assumed that real-life performance would match my calculations perfectly. I submit that I would be an equally colossal moron if my financial plans had no such margin(s).
• Firecalc.com is an invaluable resource for such planning; it will shows how your strategy would have fared historically. I submit that if the economy changes sufficiently to make those calcs obsolete, then you have larger problems than retirement, and you’re probably better off just taking off and nuking the site from orbit. Where this falls down is in personal life events and involuntary lifestyle changes, such as health issues, so this does not constitute a complete plan on its own.
• The number of years you need to work to retire can be determined by one factor, and that is Savings Rate, the ratio of how much you save per month to your take-home income. At 4% SWR, saving 50% of income results in ability to retire in 16.6 years. 25% keeps you working for 32 years. 75% gets you retired in 7 years. This is true regardless of your income level. Note that the single most powerful thing you can do to reduce your time is to reduce expenses, not increase income, but there is no reason you can’t do both. See this calculator and play with the numbers. https://networthify.com/calculator/earlyretirement?income=50000&initialBalance=0&expenses=20000&annualPct=5&withdrawalRate=4
Note that this does not take changes in spending into account, so it is best used as a tool to set a goal (i.e.I want to retire in 30 years, so shoot for at least a 25% savings rate), not as a complete retirement plan.

Anonymous said...

• With all of the above, I feel I need to put my money where my mouth is, explain my own strategy, and invite criticism. It is by no means bulletproof, but I believe it is workable. I am currently on track to be able to retire at age 50, despite making some poor choices and graduating school with significant student debt. By being able to retire, I mean that I will not need to work to cover my family’s living expenses, not that I will necessarily stop working. I will likely quit my 8-5 job in favor of engineering consulting and/or carpentry. I believe that work is necessary for my health (mental, physical, and spiritual), but that there is no reason I must do so in a “traditional job”. I am in my late 20’s (yes, a millennial), and make around $70k currently (gross), and my wife is a SAHM to our two kids. This income is fairly good to be sure, compared to the median household income in the US, but the concept is scalable; see the point on Savings Rate above. We track our spending, own a modest home, drive cars that most people would consider “beaters”, rarely eat out, perform many tasks that would be out-sourced ourselves, and most importantly, think critically about whether or not any given expenditure is a good idea. This adds up to a happy, fulfilling life, and a current savings rate of around 35%, which we are constantly trying to improve. This number includes an absurd amount of luxury (in my opinion, though someone who “needs” a brand-new Mercedes every few years would likely disagree). I use spreadsheets that I developed to track and project this (there are off-the-shelf solutions available, I just thought this was interesting and wanted to approach it slightly differently). My primary spreadsheet tracks inflation, accounts for investments, education savings for the kids, charity giving, and several other factors. I have several safety margins:
o I don’t count SS in my calcs. If it’s around and pays non-trivial sums when I am eligible, great, but if not, I won’t lose any sleep. I dislike the concept in any case.
o I don’t count any additional income that I might earn past this point, though I intend to continue performing some sort of useful work.
o I pegged my expected investment returns conservatively, at inflation plus 2.5%. I expect real-life to outperform this significantly over the long term.
o I pad my expected spending numbers to account for unforeseen expenses.
o I continue to excel in my career and expand my capabilities, to increase my income as well as reduce the chances of being unemployed for extended periods of time. I have an emergency fund in cash to help out in this event as well.
o Lastly and most importantly, I am in control of my spending. I can spend less money and accept some slight “hardships” in my life if the economy does poorly. I can do this because I am a thinking, reasoning human being and can make choices to improve my lot in life. I work on this anyway, because any reduction here improves my outcomes across the board.
• Peter, I write this not to disparage your views, but because I find the doom and gloom about financial matters extremely disheartening, and overly pessimistic. I am not convinced that the situation is as bad as articles like this portray, and believe that, most of the time, people’s financial troubles are due in large part to circumstances that are under their control. I have read your blog for several years now, and appreciate your insights. Should you find yourself in the Brazos Valley at any point, you would be welcome to a home-cooked meal and a beer. I have an IPA fermenting at the moment for which I have high hopes.
Paul

deborah harvey said...

paul,
hope you never encounter the catastrophic or chronic illness[es] in any form or in any family member.

Anonymous said...

Deborah,
I hope the same. That is in fact the point of having layered safety margins, so that even if my plans don't work out as intended, I have a reserve. In addition, healthy living and carrying health insurance should be key components of most people's long term life plan. Thank you for the input; I should have made health a larger part of my first posts.
Paul

Anonymous said...

One more point Deborah,
You are correct that any retirement plan is vulnerable to catastrophic events, health issues being one of the most pervasive and tragic. However, one is able to reduce their risk of health issues in a number of ways. There are health issues that are unpredictable and can't be prevented, but I contend that these are comparatively rare. I further contend that such issues were not the reason that the couple in the article ran out of money.

The theme of my comments is simply that the vast majority of one's life is under one's own control. The fact that some elements are not is no excuse for failing to control the ones that are.
Paul

Will said...

Paul,
what figure are you using for inflation calculations? The phony .gov numbers, or something else?

Anonymous said...

Will,
That is an excellent question. I am currently running projections at 2.5%, which I had thought represented a comfortable long term average. I am now questioning that assumption. Looking at long-term inflation data, (using the .gov numbers, for lack of better data), from 1913 to date the average rate has been 3.27%, which includes periods of both inflation and deflation. Since 2010, 2000, 1990, 1980, 1970, and 1960, it has been 1.7%, 2.2%, 2.5%, 3.4%, 4.2%, and 3.9%, respectively. This is, of course, using the .gov numbers, which you rightly point out are suspect, especially in more recent years. With that in mind, I think I will need to revise my assumed inflation rate upwards, and have a couple of questions for you:
1. Do you have a source you recommend for more accurate inflation data?
2. Do you make any similar plans/calculations? If so, what inflation rate do you use?

You will also note that I made a crude attempt to mitigate this by pegging my investment returns as "real" returns, which include inflation. While it is true that I cannot guarantee that I will get a certain real return every year, I can certainly specify a conservative estimate, which I believe I have done. While looking over my previous posts I did note an error. I incorrectly stated that I used 2.5% past inflation as my assumed investment return. I actually use 4.0%. For reference, the S&P500 has been averaging 7.0% real (11.0% total) returns from 1950.