For many years, the common wisdom approach recommended by advisors to generate cash flow in retirement for high net worth and other investors is to “draw down” retirement savings on a formula basis. To the extent these approaches may have worked in years past, there are two main reasons why a new approach is needed to create dependable retirement income over a lifetime – longevity keeps on increasing, and rates of return on retirement savings, as evidenced by the past few years, require investors taking greater investment risk and accepting greater volatility.
Two common drawdown formulas are:
1. Percentage of Savings – an investor withdraws a percentage of savings, often the rate produced by the Required Minimum Distribution (RMD) formula for Rollover IRA savings. With this approach, sample percentages currently are: age 70 – 3.65%, age 80- 5.35%, and age 90- 8.77%. The investor bears the risk of both the volatility of the withdrawals and the mismatch to income needs. Chart 1 below shows annual drawdowns and retirement savings under median and poor investment scenarios for an investor with $100,000 of retirement savings at current age 50 and planned retirement age of 65.
2. Dollar Amount Set by Formula – an investor withdraws a percentage of his/her retirement savings, typically 4% in the first year, and then increases the dollar amount of the withdrawal by the rate of inflation each year. It’s not hard to imagine the mismatch between formula driven draw downs and the rates of return on savings and investments over the past few years. As a result, investors bear the risk of running through savings because these rates of return aren’t supporting the formula-driven amounts. Chart 2 below shows sample drawdowns under median and poor investment scenarios, and the resulting effect on the amount of retirement savings.
It should be obvious that these drawdown plans fail the average investor’s need to have dependable, spendable retirement income that lasts a lifetime. In addition, these drawdown approaches are expensive and tax inefficient. Any retirement drawdown formula that is coupled with uneven market performance is likely to fail – unless investors have significant additional savings. These drawdown methods not only fail average investors, but will also unknowingly fail high net worth investors as well.
For average investors, every dollar of savings counts toward their retirement and their plans must integrate all their assets, including Social Security benefits, to provide the best solution. Thus, the overall goal of any plan for average investors should be to create the largest amount of dependable, spendable retirement income for the investor’s life span, however long that will be in the most tax-efficient manner.
We have created a planning method called Savings2Income (S2I) to provide a clear path to retirement security for those saving for retirement, soon to retire, and recently retired. S2I incorporates Rollover IRA savings, personal retirement savings held outside an IRA or 401(k) plan and Social Security into an integrated solution.