Barron's Says It's Time To Rethink Retirement Rules

Digging deep on retirement strategies.

Barron's cover story looked at a few kind-of-new ideas for managing portfolio withdrawals in retirement along with a couple of other things including strategies for taking Social Security. This is a popular topic for many people generally, something I write about here frequently and often when I post links to my Maven blog posts on Facebook, friends weigh in or ask questions.

Starting with the 4% rule, the standard building block of understanding before devising what you actually do, William Bengen determined that starting with a 4.1% withdrawal rate and then increasing for inflation every year had a better than 90% of lasting at least 30 years and actually looking backwards, the rule has always worked. Where it starts to get a little shaky is that the past was built on interest rates that have not existed for a long time and who knows when rates will be that high again like 7% or 8% for a ten year US Treasury Note. It has become more complicated by the tendency of people to spend more money earlier in retirement traveling or other activities than later when the traveling tends to slow down. Tends to, but not always.

If you read the article you will see informed suggestions that 3% should be more like it given the expectation for low returns. Another advisor quoted in the piece lays out how you can get away with taking more than 4%. A long time ago I simplified this to whatever you got, 4% meaning forget about the inflation because the portfolio will generally inflate over time. If you have $800,000 when you first retire you would take $32,000. If a year later the portfolio grew to $831,000 (so not a particularly heroic return) you would take $33,240. If you don;t need that much for whatever reason, don't take that much. The knock when I first started writing about it this way is that there is a risk of variability in how much you can take. That observation is correct but to read the Barron's piece, they seem to view this as something retirees simply need to brace themselves for.

If that last paragraph makes sense to you, then the real boots on the ground application of this would be more like every three months, whatever you got, 1%. One point about being too conservative like a 2.5% withdrawal is understanding the numbers. If you take your pot of money and divide it by 2.5, you get 40 as in your money would last 40 years assuming zero return. That ignores inflation of course in that you'd lose purchasing power but at some point you really become too conservative assuming you're relying on that pot of money to fund your lifestyle. I've laid out our scenario where hopefully Social Security, passive income from our Airbnb and maybe a monetized hobby covers our lifestyle and our pot of money goes toward travel an emergencies. We are of course trying to save money such that if something goes wrong with Social Security or our Airbnb we'll still be able to get by. If the market fares poorly we'd have the luxury of simply dialing back any travel plans to a road trip to a National Park or three. That example was in the Barron's article.

The article talks a little about when to take Social Security, advising it is best to wait until 70 which is when the payment maxes out. There are plenty of reasons to take it early. Proclaiming one age to be best for most people doesn't make sense to me but everyone should do the work to fully understand the pros and cons of various claiming strategies. For now, I continue to believe that waiting until 70 is best for us but no one knows what their future selves will want to do.

Barron's also takes a stab at sequence of returns. quoting David Blanchett from Morningstar who thinks now is a terrible time to retire because we are now after a very large rally. The rally may not be over but if it is and if a large decline s coming then a lot of retirement plans will get derailed. I wrote about this last night if you want to see more but ways to protect against this include setting aside a few years worth of expenses, reducing equity exposure by a meaningful amount or adding a large weighting to an inverse index fund. I can't stress enough though that if the rally keeps on going for a few more years then these strategies will drag on portfolio returns. I would argue that is ok, you're trading away some upside for peace of mind. That either appeals to you or it doesn't.

Where the article was about portfolio considerations it did not delve into lifestyle so I will save that for another post but there was one topic that it ignored that we've looked at many times before which is how to pull from accounts while trying to be tax efficient. If you have various types of accounts then taking from the wrong account first can be very expensive. One of my colleagues calls this hierarchy of spending, not sure if he coined the term or not. This discussion can be very emotionally and psychologically challenging, you'll see why in a minute.

Generically speaking, the most advisable path starts with drawing down a taxable account. If you sell something in a taxable account you might have capital gains tax to pay but the act of taking the withdrawal is not taxable. Here you're allowing IRA accounts (traditional and Roth) to continue to grow tax free. Imagine a scenario where a couple retires at 62 and plans to take Social Security at 67. They came up with 67 because they have enough money in their taxable accounts to cover a little over five years of expenses. In this scenario their expectation would be that they will almost completely exhaust their taxable account over the next five years like they think they will spend $40,000/yr for five years and they have $220,000 in their taxable account. They are now letting their Roth and traditional IRA grow, untouched for five years which could be enough time to add meaningfully to those accounts. The idea of depleting an account is what might be emotionally and psychologically challenging but doing this incorrectly could be very costly.

Between different types of IRAs, traditional versus Roth, I used to say to go to the traditional IRA if/when the taxable account is depleted. The Roth continues to grow and will not be taxed on withdrawals. In the example above of retiring at 62, depleting the taxable account at age 67 coincident to taking Social Security, there is an argument for these people taking from their Roth from ages 67-70 until their required minimum distribution kicks in. They pay no tax in those three years.

A sort of free agent account if you have one is the Health Savings Account. Withdrawals for medical purposes are not taxable. A sort of trick with these that I have talked about before is that if you spend $1000 on something medical when you're 55 and still working, you can hold on to that receipt indefinitely and pair it with an HSA withdrawal much later. As a practical matter, ten years later you might be spending the money on plane tickets but you're pairing the withdrawal from a procedure from quite a while ago.

Make sure you take the time to learn about these things and then figure the best way to apply them to your situation.

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