Are Safe Withdrawal Rates Really Safe?

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney

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Are Safe Withdrawal Rates Really Safe?
Jim Lange, CPA/Attorney
Guest: Todd R. Tresidder
Episode 85

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TOPICS COVERED:

  1. Introduction of Guest – Todd R. Tresidder
  2. Previous Research On Safe Withdrawal Rates
  3. The Older You Are, The Less You Spend
  4. Avoid Equity Risk If You Have A Ten Or Fifteen-Year Timeframe
  5. Factors To Consider With Fifteen to Thirty-Year Timeframe
  6. The 1.8% Safe Withdrawal Rate

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Introduction of Guest Todd R. Tresidder

David:  Hello, and welcome to this week’s edition of The Lange Money Hour, Where Smart Money Talks.  I’m your host, David Bear, here in the studio with Jim Lange, CPA/Attorney, and author of two best-selling books, “Retire Secure!” and “The Roth Revolution: Pay Taxes Once and Never Again.”  Today’s focus will be how much you can take out of your portfolio without risking running out of money during your and, if you’re married, your spouse’s lifetime.  Are so-called ‘safe withdrawal rates’ really safe?  Joining Jim by phone from his office in Reno, Nevada is Todd R. Tresidder.  A serial entrepreneur and investor, Todd is the author of two books, “How Much Money Do I Need To Retire?” plus “The 4% Rule and Safe Withdrawal Rates in Retirement.”  After earning financial independence and retiring at age thirty-five, Todd founded the Financial Mentor to share the strategies, techniques and lessons he learned along the way.  Last year, he wrote a well-received peer review article, “Are Safe Withdrawal Rates Really Safe?,” examining traditional financial assumptions in light of today’s economic circumstances.  Stay tuned for an interesting and informative conversation.  With that, I’ll say hello to Jim and welcome, Todd.

Jim:  Welcome Todd!

Todd:  Thank you.

Jim:  The area that you write in, safe withdrawal rates, I think is one of the most important areas, particularly for retirees or even people who are planning to retire, because it basically tells them how much money they need before they can retire, or looked at another way, given that they have ‘X’ amount of money, how much money can they spend?  And we’ve actually had three radio shows on this.  We’ve had Bill Bengen, who is kind of like the ‘classic’ author that Todd, you might call one of the second generation analysts, and we’ve had Paul Merriman, and we’ve had Jeff Considine, and, you know, I read all of these…well, not all of them, but I read many peer review articles on a variety of topics, and when I came up with Todd’s “Are Safe Withdrawal Rates Really Safe?” it was well-written.  It was well thought-out and I knew that I wanted to have Todd on the show, and I was lucky enough that he agreed to be on.  So, Todd, it’s a pleasure to have you on! 

Todd:  Thanks for having me on, Jim.  I appreciate it. 

Jim:  All right.  Well, one of the things that you start out with when you say in your article…and by the way, I understand the article “Are Safe Withdrawal Rates Really Safe?,” I understand that you basically kind of reformatted that into an eBook, and that’s called “The 4% Rule and Safe Withdrawal Rates in Retirement.”  Is that correct? 

Todd:  That’s correct.  You can get that on Amazon now.

Jim:  All right.  So, by the way, and this is for the audience, and I usually like to really know what I’m plugging, if you will, and I trust Todd when he says that it’s basically the same thing as the article, and the article, I thought, was excellent and gives a lot of good information.  So, that might be one resource for listeners.  Again, that’s “The 4% Rule and Safe Withdrawal Rates in Retirement” by Todd Tresidder.  So anyway, Todd, why don’t we get back to the beginning, and why don’t we start with, maybe, the, in effect, the classic rule or the static rule that many people have heard, which is four percent, and maybe even give a little introduction to what the safe withdrawal rate is for our listeners?


2. Previous Research On Safe Withdrawal Rates

Todd:  All right.  Well, as I put in the book, there’s three generations of research or thinking around safe withdrawal rates.  The first generation predates Bill Bengen’s work.  You said Bill was a guest on your show.  And that was, we just said, kind of a mortgage amortization-type model where the idea was that, you know, you can spend what your assets earned, and the problem with that it didn’t factor in a couple of critical concepts, which was…

Jim: Losing money.

Todd:  …the secret to returned risk and volatility risk and how that affects a compound return versus an average return.  And then, Bill Bengen was the first one that we all stand on his shoulders.  He was the one that really broke ground, did some very thorough research and developed what became the ‘four percent rule.’ 

Jim:  All right.  So, the first generation…and I forget who.  Somebody…oh, so basically you’re saying that Peter Lynch was just basically out to lunch when he said seven percent? 

Todd:  Well, you know, we all make mistakes.  I don’t like to highlight that because I have great respect for Peter’s work just as I have great respect for Bill Bengen’s work.  Whenever I speak on the subject, I always point out that I’m standing on his shoulders.

Jim:  Well, you do, and you even said that when we were talking before. 

Todd:  Yeah, you know, I couldn’t have any of the knowledge I have or any of the learning I have if Bill hadn’t made his breakthroughs from which we’ve all continued to develop more and more research from.  And the same thing, Peter did some great work, but he made a classic mistake.  It intuitively is appealing.  You think, “Gosh, my portfolio returns eight percent a year,” or whatever it is, on average over, you know, a hundred-year history, or whatever it is, and you think you should be able to spend eight percent a year and it just doesn’t work that way!

Jim:  All right.  So, then Bill Bengen comes along, and Bill’s book, by the way, is “Conserving Client Portfolios During Retirement,” and he comes along and says, “Hey, what we really should do is take into consideration years that you can lose money, so that the year after you retire could be the worst year that we’ve had in thirty years, and we have to take that into consideration,” and he has come up with his own, in effect, safe withdrawal rates, and these were published…let’s see, his book “Conserving Client Portfolios During Retirement,” Bill Bengen’s book was published in 2006.  So, Bill Bengen comes out in the year 2006, and he talks about depending on your life expectancy, anywhere between a 4% and an 8.9% safe withdrawal rate, and on a thirty-year, he says 4.4%.  Now, when I interviewed him recently on the radio, he didn’t quite stick by his original numbers, but…so he wanted to go down maybe 2/10ths of a percent, but he wasn’t changing it radically.  What you’re doing is a pretty significant change, so why don’t you talk about generation three and some of the problems with…again, you know, with all due respect to Bill Bengen, but some of the problems with his analysis, and why you think that yours, and the next generation in general, is probably more accurate?

Todd:  Well, what you have to do is you have to read what Bill was really trying to test.  What Bill was testing was the greatest amount that you could safely spend so you wouldn’t run out of money in thirty years, adjusting for inflation, overall time periods.  And so, it’s kind of a least common denominator-type approach, right, where you try to find that it’s the highest amount, but it pulls you down to the lowest dollar value that could’ve worked, right?  So, for example, just because you come up with a 4% safe withdrawal rate doesn’t mean that’s actually the safe withdrawal rate in all time periods.  It’s not.  It’s the lowest common one that can be found.  There’s actually…historically, safe withdrawal rates range upwards to 10%.

Jim:  All right.  And just so everybody understands the basics, if we’re talking about a 4% withdrawal rate, that means if you had a million dollar portfolio the day after you retired, and let’s assume that you wanted the money to last for thirty years, the classic Bill Bengen analysis is you can withdraw 4%, or $40,000, that year.  Then, at least, the classical definition is the following year, regardless of what the market does, you can take out $40,000 plus inflation.

Todd:  Correct.

Jim:  And following that, the second year after, it would be $40,000 plus two year’s inflation.  So, that’s kind of the classic analysis.

Todd:  Jim, it was the very assumptions behind the model that set the seeds of the problems of the model. 

3. The Older You Are, The Less You Spend

Jim:  All right, and what are some of the assumptions that you personally have a problem with?

Todd:  Well, let’s look at the definition.  He’s got a static spending formula, right?  You start with 4%, and then you adjust it upward for inflation.  Research by Bernicky shows that, in fact, every decade, retiree spending drops by 25% nominally.  So, in other words, if you age from age sixty to age seventy, statistics show that retirees will drop their spending by roughly 25% over that decade.  The other thing, too, is…

Jim:  Wait, wait, wait, actually, before you go on with that one, that’s a very interesting point because I have a lot of…in fact, I would say that probably most of us in the financial area work with…and particularly people in their sixties and seventies and beyond have maybe a little bit of a, let’s call it, a depression-era mentality where they tend not to spend.

Todd:  Right.

Jim:  And usually, the older people are, the more of that they have.  Now, are you saying that the results are tracking the same people, that is, the same people are spending less, or are people from different generations spending less? 

Todd:  No, it’s a snapshot in time, so it’s taking all sixty-year olds looking at their spending, taking all seventy-year olds…that doesn’t adjust for inflation, it doesn’t adjust for any of those factors that you’re talking about, generational changes, or anything.  It just takes a snapshot in time and says, “How much are sixty-year olds spending?  How much are seventy-year olds spending?  How much are eighty-year olds spending?” 

Jim:  Right.

Todd:  If you look, each decade of aging has roughly a 25% drop.  And there’s other studies, too.  I cite Bernicky’s because it’s one of the most popular, but there’s actually several studies out that cite a similar phenomena using different data. 

Jim:  Okay, but couldn’t that be partly just the result of older people spending less?

Todd:  Yeah, yeah.  I think, as you age, you spend less.  Your energy level drops.  You’ve already bought most of what you’ve bought.  You don’t need to be running out and buying clothes and stuff.  You’re generally pretty well established and your consumption has dropped. 

Jim:  Okay.

Todd:  But, you know, there’s other things, you know, I don’t want to get hung up on the one study because there’s other points in there too.

Jim:  Okay, that’s fine.

Todd:  Real world retirees vary their spending based on the growth or decline of their assets.  And so, it’s not realistic to have a model where, you know, you have your assets doing one thing and you have your spending absolutely unconnected to the growth or decline of your assets.  It’s not the way real people work in reality. 

Jim:  Well, I think that that is accurate, and even Bill himself said if he was going to update it, he would build in some sensitivity analysis, in other words, go up or down depending on what actually happens with people’s portfolio. 

Todd:  Yeah.  And then another thing is that…and this work has really been popularized by Michael Kitces and Wade Pfau who have done what I’d cite as a lot of the third generation research, and they very clearly documented research showing both the risk profile and the expected return related to market valuations at the beginning of your retirement, as well as inflation and interest rates.

Jim:  All right, and I know that you make a big point throughout the article and book about the time that you retire, and if you’re saying that we should be adjusting anyway, that might…of course, everybody wants to know what they should do right now, but maybe I should let you finish some of the assumptions.

Todd:  Well, what I’m trying to point out is that any sort of static model is, by definition, flawed, okay?  We all want a simple answer.  We all want to say, “The 4% rule.”  That’s why it became so popular.  It was so simple, everybody could get it.  Everybody could implement it, all right? 

Jim:  Right.

Todd:  And Bill had some great research backing it up.  I mean, I just glimpsed at the fundamental flaws behind it.  I’ve got a lot more documented in the book, but the fundamental premise is if you’re trying to shape your safe withdrawal rate strictly on your time horizon as the only factor, you’re setting yourself up for a problem because that’s not what the research shows is the driving factors behind what is your true safe withdrawal rate. 

Jim:  All right.  So, what I haven’t heard so far, which I kind of like that I didn’t hear, is I could picture somebody saying, “Well, that’s what it was twenty years ago.  Now, with the problems in Europe and the problems with inflation and the problems with the deficit and everything else, we have to be a lot more conservative,” or should that be taken into account also?

Todd:  I don’t look at any of those, what I call, ‘stories,’ because you can’t research stories and you can’t base decisions on something that doesn’t have any proven mathematical expectation.  That’s the difference between science and gambling, or investing and gambling.

Jim:  Okay.

Todd:  And so, I look at what are the drivers historically trying to connect the drivers historically to what were safe withdrawal rates in the past and connect them to what you can know right now at current times.  And so, given the high market valuations and given record low interest rates, and given the prospect for inflation, given our government indebtedness in QE Infinity, what we’re really looking at is an outlier from the data set.  We simply don’t have data to know with any certainty what the safe withdrawal rates are.  However, if you look at a correlation-based model, which Wade Pfau did do in his research, as recently as 2010, he showed based on correlation-based research, which is probably the most accurate research I’ve seen, we’re looking at about a 1.8% to 2% safe withdrawal rate, which is just jaw dropping. 

Jim:  All right.  Now, by the way, the listener should have an idea of how miserable Todd wants to make our lives.  So, he’s saying that because…

Todd:  Wait a minute!  I have no desire to make anyone’s life miserable.  I have every desire to save people from misery! 

Jim:  Well, I guess I understand that.  But just so we can be clear, let’s say, the classic solution was 4%.

Todd:  Right.

Jim:  So, if you had a million dollar portfolio, you could spend $40,000 plus inflation and keep going and not worry about what the market does in particular, within certain investment guidelines. 

Todd:  Right.

Jim:  And what you’re saying is that Bill Bengen didn’t take into a bunch of factors that maybe he could’ve, and I’m sure that you would get plenty of disagreement, in fact, one of the points of having you on, because I’m going to have other people on who, I would imagine, are not going to agree with you, and one thing that some people might not agree with is that you said that we’re actually in a very high priced market where, I assume, are you basing that on traditional price earnings ratios or what criteria are…?

Todd:  Well, pretty much the gold standard in research for measuring valuation, there are several, one is Q Ratio and another one is Shiller’s PE10, you know, the CAPE ratio. 

Jim:  All right.

Todd:  Those are kind of the gold standards, and both of those put us in the higher…certainly, the higher half and possibly the higher quartile, I haven’t looked at the numbers this week, or anything, but you’re certainly in overvalue territory by any standard definition.

Jim:  Okay.  And by the way, for our listeners, I’ll just say that not necessarily everybody would agree with Todd on that, that they would say that their…

Todd:  Generally, the people who disagree are using what we call an interest-driven model where they’re relating valuations to interest rates at the time, and those models don’t have historical data that supports them prior to about 1970.  So, they’re only kind of a recent outlier. 

Jim:  All right.  So let me ask you this: so, let’s say theoretically, we were doing some analysis before the market dropped in 2008 and 2009, and after the market dropped in 2008 and 2009.  According to your analysis, you would have a significantly different withdrawal rate because these ratios were obviously overstated, if you will, before the drop and then very favorable after the drop.  Is that accurate?

Todd:  Yeah.  If your exact date of retirement was based on that, that would be true.

Jim:  All right.  And realistically, even if you’re not retiring today this year…I mean, I have a lot of people who have retired five, ten, twenty years ago, and they still have the issue of safe withdrawal rates and frankly…

Todd:  Well actually, just have fun.  If they retired twelve years ago at the top of the market in 2000, they shouldn’t have much of an issue left at all because if you think about it, if you start with a 4% rule back in 2000, just the inflation adjusting spending would wipe out 50% to 60% or more of your account, not to mention the volatility effect.  And so, you know, the decision should be made for you.


4. Avoid Equity Risk If You Have A Ten Or Fifteen-Year Timeframe

Jim:  All right, but I guess probably what I’m interested in is providing some guidelines of what people should be doing right now.  So, let’s even say somebody was retired five, ten, twenty years ago, and whatever they did, they did, but probably what’s more realistic is, or at least of greater concern to more people, is “Okay.  I have (let’s just say a million dollars because the math is easy).  I have a million dollars in, let’s call it, some combination of savings and retirement plans, maybe Roth IRAs,” and I realize there’s different tax implications to the different types of investments, you know,  that is, whether it’s after tax dollars, IRA dollars or Roth IRA dollars, but just using a million dollars as a benchmark, if you will, because the math is easy, can you tell…and then we’ll go back to some of the assumptions in why you’re saying what you’re saying, but if you could tell our listeners what you think would be a reasonable safe withdrawal rate for a different number of years of life expectancy.  I think that would be a great thing, and maybe we’ll do that one more time at the end in case somebody doesn’t hear the whole show.

Todd:  All right.  Well, for example, prior to the show, you sent me a table that showed research from Bengen with the time horizons and the projected safe withdrawal rates and the portfolio allocations, correct? 

Jim:  Right, and by the way, I recognize that we should be saying disclaimer, disclaimer, disclaimer.  This can’t be counted on, and if you use the numbers either that Bill Bengen uses or that Todd uses and you run out of money, you can’t come back and sue us.

Todd:  Yeah.  I’m going to talk in more general terms so we don’t have to do that.  I look on it very differently from the way the whole table is structured.  I look on it completely different.  So, in other words, if you’re going to be in the ten to fifteen year time horizon, I can’t understand why anyone would allocate to equities and have equity risk exposure when the safe withdrawal rate implies less than just a straight withdrawal rate of your assets as if it had zero return.  It would seem in a time horizon that short, your mathematical expectation on stock market is not statistically knowable.  You’re just kind of at the bottom end of time horizons where you can have any statistical validity on a mathematical expectation for the stock market, and given that your safe withdrawal rate accumulates to less than the straight spending rate on the asset, I would just think it makes more sense to go into fixed income assets and just plan on liquidating principle since you can spend a higher percentage. 

Jim:  That would be true if you didn’t want to leave any money behind, and of course…and by the way, you, you know…

Todd:  Correct, but…

Jim:  I’m going to feel free to disagree with you too.  What we might do in our office, at least, is we might have several asset allocation portfolios, let’s say, obviously, heavily weighted to cash and fixed income for, let’s say, where you need your money for the next five years, then maybe a little bit more for, let’s say, five to ten years and even a little bit more stock exposure from, say, ten to fifteen years, and then, maybe after fifteen years, particularly for people in their eighties, you’re really talking legacy money, but I guess what you’re saying is, “Hey, if you have that short of a life expectancy, you’re better off putting all of it in fixed income and taking out more to spend.”  Is that right?

Todd:  I’m saying that there’s no statistical validity to any of the research in a time frame under that.  So, for example, if you look, those numbers on the tables don’t even make sense.  He’s got 40% equity allocation at ten years and 30% at fifteen years, and then it starts rising back up for longer durations.  That’s just an aberration of the data.  There’s no logic to that whatsoever. 

Jim:  I would actually agree with you on that one that it doesn’t make sense for somebody to have a higher percentage of equities with a ten-year horizon than a fifteen-year horizon.

Todd:  Yeah.  Here’s the thing, is anytime you use stats, when you’re applying it to an individual, you run into a very big risk factor, which is that for any one person, they don’t have a statistical outcome.  They have a single point.  And so, let’s say that you have a retiree who has a ten-year time horizon, they just happen to be walking to your office in year 2000, and we put them on thirty-year equities and they immediately take a 50% hiccup to that portion of the portfolio.  They’re down 15% just on that piece of the portfolio alone right before we even get started.  And so, there is no statistical validity at ten and fifteen-year time horizons, and there is no ability to afford failure at that time horizon either.  Therefore, there’s no point in taking the risk, in my opinion.

David:  Well, listen, let’s take a quick two-minute break right here, and when we return, Jim and Todd can continue the conversation.

BREAK ONE

David:  Well, welcome back to The Lange Money Hour.  I’m David Bear, here with Jim Lange and Todd Tresidder.

Jim:  So, Todd, basically, if I understand this right, what you’re saying is you believe that people with, say, a ten or fifteen-year time horizon should have a very high percentage, if not everything, in the bond markets, and therefore will be able to get the highest safe withdrawal rate by changing their investments.  Is that fair?

Todd:  Close, close.  Let me say it slightly different.  I’m agreeing with you, but I’m going to phrase it differently.  In the time frame of zero to fifteen years, there’s very little statistical validity to equity investing on almost any strategy, and so you’re basically gambling, and at that time frame, they can’t gamble, so they need to look at a different asset structure.  It might be directly on real estate, it might be income and bonds, money markets, it can be a mix of different things, but I think equities are an inappropriate risk profile at that time frame.

Jim:  Okay.  All right, and by the way…

Todd:  Except, you know, I will say this though, Jim, if valuations were extraordinarily low, like in the bottom quartile historically, and the time frame was pushing fifteen years, I could probably agree with it.

Jim:  Okay, but you’re saying for right now, for where we are, you know, sitting here today in October, 2012, you would still be uncomfortable with a time horizon of zero to fifteen years being in equities?

Todd:  Yeah.  I will say that if I had fifteen years expected lifespan starting today and I had to live off my assets, I would have zero allocation equities.

Jim:  Okay.

Todd:  That’s for my own money if it was my money.

Jim:  Okay, and very good, and the only thing is, people do have different opinions.  Today, you’re being highlighted.  I would probably have, again, a varied portfolio, particularly for people who are interested in leaving some money for heirs.  But why don’t we keep going on…?

Todd:  Just to add a clarifying point, all the safe withdrawal rate research assumes zero money left to heirs. 

Jim:  Yeah, that’s correct, that’s correct, which is why zero percent in equities might not be appropriate, particularly, and this is my area because I do a lot of work in the IRA and the Roth IRA conversion world, but in my world, the vast majority, in fact, I’d say probably about 98% or 99% of the people who make Roth IRA conversions will never spend that money.  So, having that money invested all in equities probably is a reasonable idea on the theory that the time horizon for that particular investment might not just be the ten or fifteen years that the IRA owner will live, but maybe the forty or fifty years his child, or even seventy years his grandchild, will live.  But, anyway, why don’t we keep going on to...?

5. Factors To Consider With Fifteen to Thirty-Year Timeframe

Todd:  But moving on, the next timeframe is kind of the fifteen to thirty year timeframe.

Jim:  Okay.

Todd:  In the timeframe of fifteen to thirty years…so we just talked about zero to fifteen years.  Now we’re talking about a time horizon of fifteen to thirty years.  Now that’s a whole different animal.  In that animal, you have an extensive amount of research that shows that the holding period returns you should expect relate to the valuations at the beginning of the holding period.  And that’s for time periods fifteen, twenty years, and so you’ve got a validity by which to base your equity allocation.

Jim:  All right.  So, what conclusion would you have for somebody with a fifteen to thirty year, both in a) recommended allocation, and b) safe withdrawal rate?

Todd:  That would be a function of the valuations at the beginning of the holding period.  So, for now, I would probably still have a relatively low equity allocation.

Jim:  All right, and when you say relatively low, do you mean like 70% or 80% fixed income and 20% or 30% equities, or even lower?

Todd:  I can’t give a specific allocation.  It’d be so varying with the people and all that.  I just…what I’m saying is that…let’s talk about the principles.  The principles are that your allocation to equities is going to be a function of the valuation at the beginning of the holding period that you ask statistical validity to make that decision.  There’s a variety of other factors involved too that you have to play into this.  I mean, you’ve got inflation, you’ve got interest rates, and you’ve got…there’s a lot of research that shows that the first ten years of results that you have during retirement pretty much determines your safe withdrawal rate.

Jim:  Right, but let’s say that somebody is retired now, and they’re saying, “Okay, I have my million dollars.”  Let’s assume that we accept your premise that we are in a high valuation period.  Let’s even assume that they’re using a conservative asset allocation model.  Could you give them some guideline as to what would be a reasonable safe withdrawal rate?

Todd:  I wouldn’t approach it this way, Jim.  I would approach it differently.  After all my research, all my work in the field, I think there’s really two models that I would be looking at now, which is a cash flow-based model and a model where I figure out my base level expenses and I do fixed annuities to the base level, and then I figure a higher safe withdrawal rate for the amount I’m willing to risk.

Jim:  All right.  Now, by the way, you’re getting into a closer area where I do agree with you, because I like…and by the way, I’m not a big fan at all of the commercial annuities, but immediate annuities make sense to me except…and you might…and again, you should feel free to disagree with me, it seems to me that now is kind of a miserable time to buy a fixed annuity because you’re basically locking in such a low fixed income percentage. 

Todd:  True, but the safe withdrawal rate right now is also low. 

Jim:  That’s true, but I guess what I’m trying to tell my clients is…

Todd:  Basically, what we’ve got right now is a miserable time for retirees.  I mean, I manage my mother’s assets and it’s just miserable. 

Jim:  Okay.  All right, well, why don’t we go back to your advice of what somebody should do right now with a million dollars in this, what you consider, overvaluation of the market for a fifteen to thirty year time horizon?

Todd:  For a fifteen to thirty year time horizon, I would add up Social Security and my pension.  First of all, I would figure out what my estimated expenses really are, starting with my first year.  I’d do my best to figure out my personal budget.  I would throw out this 80% rule and some of the other stuff thrown around, then I would spend some time thinking about what my retirement looks like and figure my budget.  Then I would take my Social Security income and subtract it from it, and I would take my pension income and subtract it from it, and I would figure out my shortfall.  Then that shortfall, I would take whatever I needed to to annuitize it with an inflation-adjusting fixed annuity, and I would consider myself quite safe for my base level of spending, and then all of my marginal spending, you know, trips, you know, whatever it is, just the stuff that, you know, not food, not rent, not, you know, base level things, anything above that, then I would start playing with safe withdrawal rates.

Jim:  Okay.  So, basically, what you’re saying…let’s say somebody spends…their base level is $5,000 a month.  So, what you’re saying is subtract out Social Security, subtract out a pension, and we should really go back to those because I don’t know what we’re doing about inflation for Social Security, and let’s assume a pension that doesn’t keep track with inflation, and then whatever the shortfall is, buy an immediate annuity, so your fixed expenses are taken care of.  Is that right?

Todd:  In regards to your inflation question, the bulk of the research I’ve seen, and it’s made sense for my experience in working with the generation above me, on these issues, is that your spending tends to drop with aging enough to offset the bulk of the effects of inflation to the extent that inflation remains stable. 

Jim:  Okay, so you’re going to go back to your, let’s in effect, secure the base by taking your needs, subtract out Social Security without worrying about inflation, subtract out the pension without worrying about inflation on the theory that you’ll spend less later, then whatever the need is, is to annuitize enough so that you have cash flow to meet your needed expenses? 

Todd:  Correct.  And another really fun strategy in there is if your home is paid for…what you’re trying to do is, you’re trying to get rid of any life expectancy risk, as well.  You’re trying to make sure you don’t end up eating cat food, and you’re trying to make sure that if your life goes beyond your basic assumptions that you don’t run out of money before you run out of life.  So, you get these annuitized streams built in that you could never outlive, and you get them at some functional level, and then you do safe withdrawal rates with the amount of risk capital that remains. 

Jim:  Yeah, and by the way, for whatever it’s worth, I will tell you that I’ve been in business for over thirty years now, and I find very few people who are interested in immediate annuities, just for whatever it’s worth.  I’ve talked about them and I’ve written about them extensively in my book “Retire Secure!,” but in the real world, people don’t seem to be all that interested because they can’t bear the idea of the money going poof if something happens to them, and if they’re married and dealing with two lives, if something happens to them and their spouse.

Todd:  Well, that’s probably because they haven’t spent the same amount of time you and I have looking at the risks involved.

Jim:  Well, that could be, and frankly, what you’re saying is something that I have said in the past also, which is to kind of guarantee your base, and I’ve said that, not even necessarily in the context of safe withdrawal.  So, let’s assume…on the one hand…

Todd:  The way we got in this conversation is you were trying to peg me down on an exact equity allocation, and I was trying to let you know that I really wouldn’t even look at it that way.

Jim:  Right, and I’m even willing to forget the exact equity allocation, but I would like to nail you down on a percentage, but I guess what you’re saying is you would take care of the fixed, you know, let’s call it a roof over your head, food on the table, gas in the car, you want to take care of that with Social Security, pension and immediate annuity?

Todd:  Yeah, and I might even have my house paid for and plan on living in it while I was independent and everything, knowing that I could sell it when I’m really crotchety and old, and harvest the equity out as another ticker to keep me going. 

Jim:  Yeah.  What Jonathan Clements says, for whatever it’s worth, is that you could take 60% of the value of your house and add that to the number that you use for the safe withdrawal rate, and I actually just had a mortgage guy on who was saying that the reverse mortgages are much more affordable and much less fee intensive than they used to be. 

Todd:  But anyway, I think that we covered the fifteen to thirty year, which is you’re dealing with life expectancy risks, you’re dealing with a period where you actually have predictable math…not predictable, I hate that term, mathematical expectations for the stock market returns that have some validity.  You know, you’re dealing with certain statistical validities in there, but you’re also dealing with certain other risks involved.  Once you hit the thirty-year plus time horizon, all bets are off.  Everything changes at that point. 

David:  Let me break in here.  We’ve got one more break to take, and when we return, Jim and Todd will continue this conversation.

BREAK TWO


6. The 1.8% Safe Withdrawal Rate

David:  Welcome back to The Lange Money Hour with Jim Lange and Todd Tresidder, founder of financialmentor.com.

Jim:  Okay, Todd.  Now, a couple times, you have said, “Well, you want to take care of your fixed expenses by Social Security, pension and annuitizing.”  Let’s say that, like most people, they say, “Hey, I don’t quite buy into this annuitizing.”  So, what do you think that they can use as a safe withdrawal rate?  And I’ll even give you license to do any asset allocation you like. 

Todd:  Well, what I can say is the correlation-based models are just the most accurate models I’ve seen where it points to a safe withdrawal rate under 4%, which is why I point to the annuity at this point in time is because fixed annuities can be purchased with higher yields than the current safe withdrawal rates indicate.

Jim:  All right.  How much…?

Todd:  I do want to add something though, Jim.  I want to clarify, they may not buy off on an annuity.  As long as they’re really clear that what they’re really saying is they would sooner take the risk of a safe withdrawal rate than give it to the insurance company.  That’s what they’re really saying when they make that choice, and I think that’s a very different statement than saying I’m not willing to buy an annuity. 

Jim:  All right, fair enough.  You said less than 4%.  There’s a big variation between zero and 3.9.  How high are you willing to go?

Todd:  I don’t know.  I haven’t actually looked at the research since 2010, so I can’t tell you.

Jim:  All right.  What would you say if it was 2010?

Todd:  Well, I didn’t say it.  Wade Pfau did the research, so I don’t want to take credit for his work.  His research…he did a correlation-based model which, amazingly, this is amazing, correctly forecasted the safe withdrawal rates using historical data within one percent of what it actually turned out to be, and given the wide variation in historical safe withdrawal rates, that’s an amazing result, and his research, as of 2010, showed 1.8%.  Now, what that’s pointing out, and that was tying back to our opening discussion about Bill Bengen, is that the time period we’re in right now is already out of sample.  That’s another assumption behind the Bengen research is that if you look at U.S. historical data, that it somehow encompasses all risk and all expectations that we can have going forward, and what’s going on right now is we have record low interest rates coupled with high valuations creating a time period that never existed in historical data.  And that’s why we have expected safe withdrawal rates below historical averages. 

Jim:  All right, so what you’re really saying is, and again, I don’t mean to put words in your mouth, but if you don’t like the annuitizing idea, and you are willing to say, “Hey, I’m going to take that risk,” but you’re saying closer to 1.8% would be appropriate, where a Bill Bengen follower might use 4%.  So basically, you’re saying you can spend half as much money as Bill Bengen says.

Todd:  If you want to put me on a hook like that, I suppose I would stand on it.  I would say that it’s not a lot different than somebody who would’ve supported the 4% rule back in 2000, and now, twelve years later today, is sitting with the 60% or 70% drawdown in their assets just through spending alone.  When you’re at overvalue periods, you’re just taking an extraordinary risk, and with record low interest rates, it’s probably one of the most difficult periods ever in retiree history. 

Jim:  Well, let me ask you this: what if…you said before if you use some common sense and be flexible, what if you were to say, “Well, what if I take 4%, or even 3%, now, but I am willing to change my allocation if the market does go down significantly and my principle goes down.”  Could you then justify taking higher than 1.8%?  I’m trying to give our listeners some hope here because otherwise, they’re going to take the bridge!  They’re going to say, “Oh, man, I’ve been taking 4%, and this guy says 1.8%, and if he’s right, we’re going to run out of money!”

Todd:  Yes.

Jim:  So, I’m trying to…

Todd:  I’m agreeing with you.  Yes, that statement is 100% true!

Jim:  Oh, man, nobody’s ever going to listen to us again. 

Todd:  Well, you know, you can thank Ben Bernanke for his record low interest rates in Warren Savers.  We’re just delivering the message.  We’re not the ones who created it.

Jim:  Okay, but again, let’s say that somebody says, “Okay, if I am willing to reduce my lifestyle if the market goes down,” would that be a justification of taking a higher safe withdrawal rate right now?

Todd:  Actually, there’s some really fun ways you can take a higher safe withdrawal rate now.  You can make your spending so it doesn’t adjust for inflation, okay?

Jim:  All right. 

Todd:  That gives you a higher safe withdrawal rate as of today.  Another thing you can do…

Jim:  That’s not fun, though.  Tell me something that’s more fun! 

Todd:  All right, well, the math is the math.  Another thing you can do is you can spend as a percentage of the assets, and that virtually eliminates the risk of running out of money, but it gives you a fluctuating spending amount.

Jim:  That actually makes some sense because that’s kind of what I do.  When I meet with clients, we always…you know, let’s say I do it in the context of safe withdrawal rates, but I might say, “Okay, you can spend 4% of what you have right now,” and then, let’s say the market goes down 20% and their portfolio is down 10%, let’s say half stock and half bonds, so the amount the following year will be lower, but isn’t that a form of just being willing to adjust what you spend in the future?

Todd:  From both Pfau and Kitces, shows conclusively that the returns you experience in the first ten years of your retirement is pretty much the determinant.  And so, if you, in fact, have a retiree who goes through an abysmal return period in the early period of their retirement, it’s pretty much conclusive evidence that the true safe withdrawal rate from the starting point in their retirement was considerably lower than estimated. 

Jim:  Right, but let’s say now, they’re into it, so they would just have to adjust their spending now. 

Todd:  That’s what I would do, and that’s what most real world retirees do, in fact. 

Jim:  Right.  So, let’s say that somebody had a 4% safe withdrawal rate.  It turns out now they have less money.  Could they just say, “Okay, I’m going to spend 4% of what I have now?”

Todd:  Yes. 

Jim:  All right.  So, maybe that is the conclusion, that everybody doesn’t have to jump off the bridge, that they can take, more or less, 4% of what their total assets are, being prepared to spend less if the assets go down. 

Todd:  And I will just add in, it wouldn’t be my first choice.

Jim:  Right. 

Todd:  I think I would sooner…my viewpoint is, I would sooner annuitize and create cash flow streams that support my base spending, and then I will take risks with the money that remains, recognizing that I can pull a much higher spending rate, because basically, you know, if you’re sixty, can you get twenty good years out of the money without going above and beyond your base spending?  That’s probably good enough. 

Jim:  Okay.  You know, I’m afraid we’re going to have to wrap up, but let me just give our listeners some resources.  One is the book, “How Much Money Do I Need To Retire?,” and the other one, which is, let’s say, an e-book that is based on the peer review article that I read that I think has a lot of good information, is “The 4% Rule and Safe Withdrawal Rates in Retirement” by Todd R. Tresidder, and they are both on Amazon.

David:  Thanks for listening to this edition of The Lange Money Hour, Where Smart Money Talks, and thanks to Todd Tresidder for sharing his financial insights.  As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning here on KQV, and you can always access archives of past shows, including written transcripts, on the Lange Financial Group website, www.retiresecure.com.  Please join us for the next new Lange Money Hour on Wednesday, October 17th at 7:05 right here on KQV.  Jim’s guest will be Sandy Botkin, CEO of the Tax Reduction Institute, which specializes in the creation and distribution of information to help independent contractors and small business professionals legally, morally and ethically reduce their taxes.  It’s sure to be an interesting show, and mark your calendars for an upcoming show in November, when we’ll have Jack Bogle, who is the founder and long-time chairman of Vanguard Group, the world’s largest mutual fund.  He’s a revered author and commentator.  You’re sure to enjoy that show.  Until then, I’m David Bear.

END

 

James Lange, CPA/Attorney

Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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