A new challenge emerges once you’ve hit the golden age of retirement.
As retirees shift from being income producers to asset spenders, how they draw down their retirement assets matters. With life expectancies increasing and medical costs soaring, it can be difficult to know how much to take out on a yearly basis.
The traditional 4 percent rule suggests retirees could safely withdraw that amount of money each year in order to sustain a nest egg over 30 years. There is widespread debate whether that is still valid. Current and future projected financial markets are different than when the rule was developed, says Ann Minnium, certified financial planner at Concierge Financial Planning in Scotch Plains, New Jersey.
“I don’t believe the 4 percent rule is relevant today,” Minnium says. “There has been much debate on what the new ‘4 percent’ should be, but there has not been a consensus. I’ve heard anywhere from 2.5 percent to 3.5 percent. I would caution retirees to not rely on the 4 percent rule.”
[See: 10 Costs You Can Eliminate in Retirement.]
Retirees are to some extent dependent on market performance when a portion of their portfolio remains invested in stocks. Sequence-of-returns risk, or the potential for lower or negative market returns during the early years in retirement, is another factor retirees must navigate when drawing down a retirement nest egg.
Do not panic and draw from equities in a down market, Minnium says.
“This is going to have to be mind over matter because in a strong bear market your emotions are going to get the best of you,” she says. “I had a client who came to me some years after the events of 2008. During the financial crisis he panicked and sold securities, which ended up leaving him with a $400,000 loss. He was too scared to re-enter the market. If he had left his investments in the market that $400,000 loss would have been worth $1.5 million by the time he came to see me. Unfortunately due to his rash behavior he was not able to retire when he wanted to and had to continue working.”
The math hurts when you are withdrawing income and losses occur at the same time, says Barry Butlien, certified financial planner at Westchester Financial Advisors based in Tarrytown, New York. The market can also work in your favor.
“If you are fortunate enough to retire at the start of a bull market, and you experience very good returns in the early years, your nest egg may grow significantly despite the withdrawals you are taking,” Butlien says.
Here are strategies retirees can utilize:
Spend less during market downturns. “If not, at least try to delay your big purchases until after the markets recover,” says Neil Krishnaswamy, certified financial planner at Exencial Wealth Advisors in Frisco, Texas.
Be flexible with your asset allocation. When you need to withdraw money, sell investments that have high valuations or those with lower future expected returns, Krishnaswamy says. “For example, if the bond portion of your portfolio is up and your equity positions are down, it may make sense to sell only the bonds for this year’s living expenses,” he says.
Purchase income annuities. Income annuities can offer unparalleled protection against sequence-of-returns risk, Minnium says. “Their payments are guaranteed and do not depend on market performance,” she says. “Annuity issuers are able to pool the sequence-of-returns risk of their investors who work and retire at different times. This is the same way your insurance company provides your homeowners insurance. Those who experience hurricane damage and receive reimbursement are being funded by those who did not suffer any harm.”
Delay taking Social Security. Social Security is the best income annuity out there, Minnium says. “It’s an inflation-linked stream of payments you cannot outlive. By delaying your benefits until age 70 you can obtain a lifetime of higher payments without sequence-of-returns risk,” she says. “In fact, your benefit will start 76 percent higher if taken at age 70 than it would have been if started at 62. There is nothing to buy or allocate here. All you have to do is be patient and wait.”
[Read: Is 4 Percent Still the Safest Retirement Amount?]
Use a reverse mortgage. If you own a home, you could use a reverse mortgage line of credit. “In the event of a significant market decline you could opt to draw your living expenses from the line of credit instead of from your depressed securities,” Minnium says. “When market conditions improve, you could pay down the line of credit.”
Allocate with buckets. Another strategy to help ensure your retirement nest egg will last throughout your lifetime is to use the bucket approach. The retiree divides their assets into several different “buckets” intended to provide cash flows for a specific time period, Krishnaswamy says. A three-bucket approach could have a short-term bucket that provides income for the first four years, the next bucket provides income for years five through 10, and the final bucket provides years 11 and beyond.
“Based on the time horizons, each bucket could be invested differently,” Krishnaswamy says. “The first bucket might have all fixed income and cash. The third bucket might have all equities. Of course as time marches on, the first bucket would have to be replenished and other buckets adjusted accordingly.”
Bucket strategies offer confidence for near-term cash flow. “As an investor, it could provide peace of mind knowing how you will fund say the next one to two years of spending because you have that amount set aside in your cash bucket,” Krishnaswamy says.
Remember the tax man. Retirees also need to consider the tax implications of their withdrawals. “Most people forget any withdrawals from an IRA or qualified account are 100 percent taxable,” says Cary Carbonaro, managing director at United Capital in New York. “For example, if you took $100,000 out of your IRA and were in the 30 percent bracket, you would owe a $30,000 tax on it, too.”
[See: 7 Stocks That Will Ruin Your Portfolio.]
Consult a specialist. Drawing down your retirement nest egg safely may be more difficult than it appears. Don’t go it alone, Butlien says. “Find a professional who you can trust, who takes the time to really understand what makes your situation different from the next person,” he says. “This is crucial.”
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How to Safely Spend Your Nest Egg originally appeared on usnews.com
