Retirement planning is a daunting concept, so it’s no surprise a lot of people rely on rules of thumb to provide a quick sense of whether they’re on track or not.
The trouble is, today’s rock-bottom interest rates mean a lot of the old rules of thumb no longer work like they used to. (For more on the problems with low rates, see my WSJ Letter to the Editor.)
Take the well-known “4% rule,” which has been part of retirement planning for decades. That’s typically been what a retiree planning on a 30-year retirement could withdraw each year without running out of money. In other words, for a typical 60% bond/40% stock portfolio, a retiree could withdraw an inflation-adjusted 4% annually. For someone with $500,000 in their 401(k) Plan or IRA, that means they could take out $20,000 annually.
But now that rates have collapsed to historically low levels, that math may not work anymore. The portfolios don’t generate as much as they used to. So consensus has moved to recommend people withdraw only 3 ½% or even 3% annually to make sure they don’t deplete their funds too quickly. At 3%, that means withdrawing only $15,000 a year now from that $500,000 portfolio.
As a result, many people will now not have enough to maintain their expected standard of living in retirement.
What’s the answer? One wise move for healthy people is to delay taking their Social Security benefits to increase their monthly benefits. Delaying it to age 70 can increase it by 24% if your “Full Retirement Age” is 67. However, it was reported in 2018 that only 6% of women and 4% of men delayed taking their Social Security benefits to age 70. In fact, 31% of women and 27% of men claimed their benefit early, at age 62, reducing their benefit for life.
Another option is to take a portion of your 401(k) plan (or IRA) and purchase an immediate (or deferred) annuity. This will provide monthly lifetime income by taking advantage of “mortality credits”–especially for healthy people–and offers more income than many current bond yields or Certificate of Deposit (CD) rates.
These steps can all help to offset the damage of low rates, increase retirement income, and keep retirees from being a “reverse legacy”–becoming dependent on family members for financial help.
As Reverend Milton Wright, father of the aviation pioneer Wright brothers said: “All the money anyone needs is just enough to prevent one from being a burden on others”.