Your Clients Are Getting Older. So What?

The reason that retirement withdrawals are not all that destructive is the simple fact that in the early stages of retirement, withdrawals relative to total assets tend to be rather modest. For instance, the chart below shows how rising spending (yellow line) impacts a retirement account balance (red line) over time, assuming an 8% growth rate on a balanced portfolio, and an initial withdrawal rate of 6.6% that rises each subsequent year for inflation (i.e., $66,000 withdrawal in year one on a $1 million portfolio, and the $66,000 withdrawal amount is increased in each subsequent year for inflation). 

As the numbers show, and as evidenced by the fact that withdrawals start at a rate (6.6%) that is less than the growth rate (8%) on average a retiree at age 60 doesn't actually begin to deplete the account balance at all until almost halfway through retirement. It's only by the client's mid-70s that the account balance even begins to decline, and several more years after that before it dips below where it started, and only then finally experiencing the rapid spend-down in the later years.

Of course, the caveat to the chart above is that portfolios that average 8% don't necessarily earn it every year, and not every retired client dies "promptly" on their 90^th birthday; some live longer. As a result, even assuming an average growth rate of 8% on a balanced portfolio, clients are not recommended to spend the 6.6% initial withdrawal rate that "works" based on the above straight-line projection. Instead, the standard safe withdrawal rate is actually 4%, to defend against such unfavorable sequences, unexpectedly longevity, etc.

Yet in turn, it's important to bear in mind that when balanced portfolios average 8% and the withdrawal rate starts at only 4%, in the overwhelming majority of scenarios, clients will simply outearn their spending level, sometimes quite dramatically. Moreover, wealth is more likely to compound upwards than spend down at all. In fact, as Bill Bengen's original safe withdrawal rate research showed, in 96% of historical scenarios a 4% withdrawal rate finishes with at least as much nominal principal at the end of 30 years that it started with; in the median outcome, clients following a 4% safe withdrawal rate approach actually more than quadruple their wealth over their retirement time horizon!

Which means that ultimately, there is actually very little danger that ongoing retirement withdrawals will totally deplete a retiree's asset base. Even if it does, it's not likely to happen until the very last years at the end of retirement as clients move into their 80s and beyond. Notably, while some consultants caution about the impact once clients reach age 70 ½ and begin required minimum distributions from traditional IRAs, the reality is that if clients don't actually need to spend the money. An RMD is simply a transfer from an IRA to a taxable account that doesn't necessary change the available assets to manage, beyond perhaps the portion attributable to income taxes that may be payable from the investment assets.

In part two of this posting, I'll take a look at another perhaps surprising finding about retirement: the survival rate of married couples.