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By Dr. Jim Dahle, WCI Founder
Countless ink has been spilled and numerous research papers have been published on the subject of retirement spending, specifically how to spend down a nest egg in retirement. There is this widely believed perception out there that the decumulation years are dramatically more complicated than the accumulation years.
I’m not sure that’s actually true. For example, I manage my parents’ portfolio. I kid you not when I tell you that it takes me less than an hour a year, and most of that is updating the spreadsheet and writing them a letter at the end of the year telling them how their portfolio did. I only log into the accounts twice during the year—once to rebalance and once to take RMDs. Frankly, if we just did both of those chores at the same time, it would cut that effort in half. Meanwhile, I’m having to invest money into our own accounts every month, track investments, evaluate new investments, and read up on new retirement account options and contribution limits.
Retirement investors should also be experienced investors. No need to relearn about market history or fight to control their investing behavior or take on a new job or cut spending to boost their savings rate or any of those other things that young investors do to be successful. The hardest part for most retirees is just learning how to spend more money on things and experiences they care about, so they don’t die the richest folks in the graveyard. Cry me a river.
Retirement Withdrawal Plans
Engineers and financial nerds love to geek out on comparing and coming up with new methods of decumulating. The varieties of possible plans are endless. I think that most people have concluded by now that the simplified method used in the Trinity Study (4% of the original portfolio value, adjusted up with inflation each year) is probably not the best withdrawal method. So, they’ve come up with dozens of variable and fixed methods.
We’ve talked about a bunch of them in the past year or so in what basically became a blog series on decumulation:
But let’s be honest, most people want a simpler solution. And that’s probably a good thing. Rather than go over a dozen or more complicated methods of spending down your money, I’m going to cover four very simple methods. All four are simple. All four are VERY commonly used. I’ll explain the upsides and downsides of each one, but the main upside of each of them is its simplicity. Even a half-senile 88-year-old can handle each of these methods with little assistance, unlike most of the stuff put out by academia.
#1 Spend Whatever You Want
The first method is what I call the “spend whatever you want” method. This is actually a really commonly used method and is the withdrawal plan that Katie and I will be using. The main upside is that you don’t have to track anything or put any sort of limits on your spending, and that’s obviously very attractive. The downside is that it requires you to be very wealthy relative to what you wish to spend. But for many people who work long after they’re financially independent, this is a fantastic method. Maybe the best. When you see people on forums talking about only spending 1%-2% of their nest egg a year, this is basically their withdrawal plan.
More information here:
Beyond Financial Independence: Money Irrelevancy
Life After Financial Independence: Two Perspectives
#2 Spend the Income (Never Touch Your Principal)
This is a silly method in a lot of ways, but it’s actually a very frequently used method. It typically produces an annual spending amount that is not all that different from the “spend whatever you want” method. The upside is that it isn’t hard at all to tell how much you’re supposed to spend in a given year. You spend your interest, your dividends, your rents, and your bond coupons. If there’s any Social Security or pensions, you spend that, too. But you never touch your principal.
The main downside is that since you’re not immortal, you’re going to leave A LOT of money to your heirs that you could have spent on yourself. You’re likely to die with a large multiple of what you retired with. There is a minor downside, that you might be tempted to preferentially invest in investments that provide a high income despite not having a very good risk-adjusted total return. This can result in bad investments and inefficient taxation.
#3 Adjust as You Go
The first two methods are for those who are pretty wealthy. If you’re not all that wealthy, you’re much more likely to select this method. Taylor Larimore, co-author of The Bogleheads Guide to Investing, selected this method back in 1980 when he retired with $1 million. Forty-five years later, he is 101 years old and doing just fine with his money. He simply adjusted his spending as he went, keeping an eye on the size of the nest egg and his life expectancy.
Before retiring, we all made adjustments in our lifestyles and spending for many decades; why couldn’t we do the same after retiring? Nobody in their right mind who retires with a halfway decent nest egg is going to just keep on spending as its value approaches zero. The upside of this approach is that it usually allows for a much higher spending amount than the 4% prescribed by the Trinity Study. It also allows the flexibility to spend more during the “Go-Go” early retirement years and less during the “Slow-Go” and early part of the “No-Go” years before healthcare expenses go through the roof. The only real downside of this method is that you actually do have to pay at least a little bit of attention to your nest egg size, investment performance, and ongoing spending. Your heirs are also likely to get a smaller inheritance as you optimize your own spending.
How can you tell if this is a method you should consider? It’s really a measure of your wealth. Not absolute wealth but relative wealth; how much you have compared to how much you want to spend each year. If you’ve only got a nest egg that is 15-30 times your annual spending, you should definitely use this method instead of the “spend whatever you want” or “never touch your principal” method. If you have less than 15X your annual spending, you should give serious consideration to the purchase of guaranteed income streams such as Single Premium Immediate Annuities (SPIAs) with some of your nest egg.
More information here:
How to Spend Your Nest Egg — Probability vs. Safety First
#4 Spend the RMDs
A surprising number of investors worry about having an “RMD problem.” After saving gobs of taxes throughout their accumulation years, they’re bummed that the government wants their cut of those tax-deferred accounts, especially if those withdrawals also increase their IRMAA or ACA payments. These folks are taking the money out of their tax-deferred accounts, paying the taxes on it, griping and moaning about it, and then reinvesting that money in their taxable account for their heirs. This might be the most desired financial problem in the world. However, it leads to the last of our four investment methods: spending the RMDs.
Here’s a novel concept. Required Minimum Distributions (RMDs) are actuarially determined. For most of us, they’ll start at age 75 at about 4% of the prior year’s balance and gradually climb into double digits in our 90s. Why not just spend the RMD? The upsides of this method are that it is actuarially sound and completely reasonable, and your IRA custodian will even tell you how much to spend at the beginning of every year. You’ll never go broke following this method either, although it is possible with terrible investment returns that your “income” could get very small eventually. The downside of this method is that it doesn’t really work for two of the three types of investing accounts. There are no RMDs for taxable or Roth accounts. You could simulate them, though, by applying the same RMD percentage used with your tax-deferred account to your other accounts.
Combining the Methods
There is also no reason why you can’t use more than one method. For example, you could combine the “spend the income” method in your taxable account with the RMD method from your tax-deferred accounts. So, you might spend your Social Security and pension income, plus the interest and dividends from your taxable account, plus your RMD. You could then use principal withdrawals from the taxable account and Roth withdrawals for large one-time expenditures, effectively adjusting as you go.
The decumulation phase does not have to be complicated. Very simple and commonly used withdrawal methods are actually very robust and completely reasonable. Millions of high-income earners have retired before you and have done just fine. There’s no reason you can’t do the same.
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What do you think? If you’re retired, what method are you using to draw down your assets? If you’re not yet retired, what is your planned withdrawal method?