Q: I am going to be retiring in a few months. I will probably roll over my company 401(k) plan to an IRA. How much can I safely withdraw from my account to supplement my Social Security? I am 65 years old and I don’t want to completely deplete the account.
A: Determining appropriate withdrawal rates is an area of financial planning that is receiving a lot of practical and academic attention. With the popularity of defined contribution plans such as 401(k)s, etc we are seeing an increase in the need for such planning. In the past many people depended on Social Security and/or defined benefit plans such as company pensions. There has been a shift from company-provided pension plans to plans that the employee has more control over. This can be good, but instead of a guaranteed check each month; retired employees must determine how they can turn this “pool” of money into a sustainable lifetime income.
There is no magic formula, but there are some things that you must consider. First you must consider how long you need the money to last. You can find many resources to determine an “average” life expectancy. With health care advances and healthier lifestyles the number is moving further out the curve. Planning for 30-year retirements is not uncommon. Next you have to consider the impact of inflation. A dollar 10 years from today probably will not purchase as much as a dollar today. The U.S. Bureau of Labor Statistics has developed an index, known as the CPI-E. This index is intended to track the spending habits for those over age 65. This index indicates a 25-year 3.33 percent annual inflation rate for the goods and services tracked. Contrary to some opinions this indicates that inflation is a more significant factor in the retirement years than it was during the working years.
How you invest or deploy the money is another key factor. It is important to continue along a prudent investment strategy that is neither too aggressive nor too conservative. Too aggressive can subject you to the effects of poor investment performance that might be difficult to recover from. Too conservative may prevent the portfolio from keeping pace with inflation and to provide a comfortable standard of living. Finally, the spending rate must be determined. There are many strategies out there. Some advocate a starting rate that is adjusted for inflation each year. Others set a starting rate and then adjust it based on the performance of the portfolio. There are many other different opinions on the appropriate rates and adjustment techniques. All of the research and consensus seems to indicate an initial withdrawal rate of 4 percent to 5 percent (of the starting principal), with some type of inflation adjustment, is a prudent amount. “Rules of thumb” should be used very carefully. Your situation is unique from the next person’s and only after careful review and monitoring can an appropriate rate be determined for you.
It is important to have someone review all the variables that affect a sustainable strategy. I would encourage you to segment funds into different “buckets.” You need liquid funds, short term funds, and growth oriented longer term funds. You also have the option of guaranteeing certain payouts and/or death benefits with various products offered through insurance companies. Remember, the guarantees offered by insurance companies are based on the claims paying ability of the insurance company.
Planning for retirement income should be an area where you seek professional guidance. Errors or mistakes made during this time can be much less forgiving and much more devastating than those made during your accumulation years.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Greg Epps is a registered representative and Certified Financial Planner with Epps Financial Partners. Securities are offered through NEXT Financial Group Inc., member FINRA/SIPC. Submit questions to his attention by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at jvass@timesfreepress.com.