One comment I’ve received over the years when working with a new client is, “I want to spend all of my money before I die.” Or said another way by the character Saul Bloom in the movie Ocean’s Twelve, “I want the last check I write to bounce.” This idea sounds very simple and elegant, but the reality is more like the unpredictable, all-over-the-place capers of the Ocean’s gang.
Let’s say an age 65 retiree has $500,000 of investment assets and wants an annual, inflation adjusted income to supplement whatever other sources of income there may be. Our retiree believes she will earn an average annual 7% in a balanced portfolio and she will live to an average life expectancy of age 88 based on good current health. Doing some basic math, we find that she can begin taking $31,000 annually, adjust for 3% inflation each year and then run out of money precisely at age 88. There’s several problems with this, we’ll focus on just two.
The markets don’t return 7% every year. Returns vary annually, creating uncertainty of outcomes. Assuming our retiree gets her age 88 life expectancy correct, the variability of returns tell us that there is only a 59% probability of not exhausting the portfolio value by age 88. Most people aren’t comfortable with that probability and we believe it should be at least 75% for someone this age. To increase the probability to this level, the starting annual withdrawal has to be dropped to $28,300, a $2,700 decrease from the initial “spend to $0” amount. But then there’s the second issue.
Depending on what life expectancy table you consult, an age 65 female has an average life expectancy of age 87-89. So, choosing 88 means that she has a 50% chance of living to age 88. This also means she has a 50% chance of living beyond age 88. Therefore, planning to die by age 88 would only account for half of the possible outcomes… not a good planning assumption.
Here’s a table summarizing various ages, probability of living to those ages, and “safe” beginning withdrawal amount assuming we want at least a 75% confidence of not running out of money by each age.
The last column shows the remaining value at each age assuming our hypothetical 7% return every year. As you can see, the longer the time horizon, the lower the safe withdrawal amount and the higher the portfolio value needed to maintain the confidence level. This makes sense given that the longer the time horizon, the longer the time for various outcomes, though note the decreases in the safe withdrawal amount become smaller the further out you go.
This simple example highlights the fact that it isn’t really possible to run out of money when you die AND not run a significant risk of running out before then. Incidentally, my standard advice for this age client is to plan for a life expectancy to which they have a 30% chance of living, in this case age 93. This isn’t the right answer (there is no right answer when dealing with probabilities), but I believe it’s a prudent balance between planning for longevity risk and not underspending throughout retirement. It also allows for ample time for adjustments along the way.
Finally, this is a very simple example. In practice, there are many more factors to consider, such as:
- Other sources of income and their dependability
- Future obligations
- Client expectation of risk and return
- Specific health and family history
All of this becomes very specific to each client and must be fleshed out through both discussion of these variables and then modeling in financial planning software. Going through this process and then keeping it updated provides a greater understanding of the realities of safe withdrawal rates and a framework to respond to changing conditions.
Any information presented here is general in nature, believed to be reliable as of the date published and is not intended to be and should not be taken as legal, tax, investment or individual financial planning advice. Competent, licensed professionals should be consulted when implementing any kind of financial, estate, tax or investment strategy.