You don’t know how long you’ll live, what the inflation rate
will be and what investment returns you’ll earn. Still, many financial experts
have settled on a 4% withdrawal rate, meaning you spend 4% of your portfolio’s
value in the first year of retirement and thereafter step up your annual
withdrawals with inflation.
Laurence Siegel and M. Barton Waring don’t think that’s
reasonable. Mr. Siegel is director of research for the CFA Institute Research
Foundation and Mr. Waring is the retired chief investment officer for
investment policy and strategy at Barclays Global Investors. They have a
working paper on the topic that they’re currently circulating.
Their key point: You shouldn’t expect a fixed-income stream
from risky investments.
Adjusting annually:
You could live off savings early in retirement while delaying Social Security
until age 70, so thereafter you have a healthy stream of inflation-indexed
income. For additional lifetime income, you could use any remaining savings to
buy immediate-fixed annuities, preferably those that pay income that rises with
inflation.
Alternatively, to generate a predictable stream of
inflation-adjusted income, you might live off a ladder of inflation-indexed
Treasury bonds with different maturities. Today, the longest-dated
inflation-indexed Treasury matures in 30 years. You’d need a backup plan if you
lived longer than that.
But what if you don’t like these strategies—and prefer to
own some mix of stocks and bonds? Messrs.
Siegel and Waring propose what they call an “annually recalculated virtual
annuity.” The idea is to recalculate how much you can spend each year by taking
your year-end portfolio value and figuring out how much you can spend over your
remaining lifespan, assuming the current level of real interest rates.
The annual calculation would result in year-to-year
fluctuations in your income. For most folks, the “annually recalculated virtual
annuity” would involve a daunting calculation which could easily be solved with
a simple phone app. Until that app exists, what’s the alternative? Suppose you
believe you’ll live 20 more years. You might simply spend 1/20th of your
portfolio’s current value in the first year, 1/19th in the second year and so
on. That wouldn’t be ideal because you would likely end up shortchanging the
early years of your retirement.
Living long:
Mr. Siegel suggests devoting 75% of your savings to the annually recalculated
virtual annuity and use that strategy to carry you through to age 85.
What about the other 25%? That would be your financial
backstop should you live beyond 85. Mr. Siegel says you might use part of this
money to buy deferred-income annuities, sometimes known as longevity insurance.
With these annuities, you hand over a chunk of money to an
insurer and, in return, receive income for life starting at a future
date—assuming you live that long. For every $100 invested in a deferred-income
annuity at age 65, a man could get perhaps $37 a year starting at age 85 and a
woman might receive $33.
Mr. Siegel notes that insurance companies can go bankrupt,
so you might purchase annuities from multiple insurers. Indeed, because of the
bankruptcy risk, he suggests investing just half of the 25% in annuities—and
keeping the other half in a conventional mix of stocks and bonds.
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