The approach of retirement should be an exciting time for 50- and 60-somethings. But when the issue is your finances — and whether you’ve saved enough to last the rest of your life — excitement can quickly be overridden by anxiety.
One of the first decisions retirees must make is how much of their savings to spend in the first years after leaving full-time work. And unfortunately for people now contemplating retirement, the math on tapping one’s nest egg has rarely looked so daunting.
It’s bad enough that many Americans have saved too little. But even those with substantial savings face the prospect of earning dismally low returns on stocks and bonds for years to come. That’s because U.S. stocks look pricey after a seven-year bull run, while yields on high-quality bonds remain in low-single-digits.
Worse for savers, hopes have dimmed that the Federal Reserve would aggressively push up short-term bank interest rates this year from near-zero levels. After a quarter-point rate hike in December the Fed has paused, and Chairwoman Janet L. Yellen said last week that global economic concerns dictated that the central bank should “proceed cautiously.”
That calls for careful planning both for people already retired and those approaching that red-letter day. By first establishing how much you can afford to take from savings each year, you can determine whether you’ll want to try to earn part-time income in retirement, take Social Security early or perhaps delay retiring altogether if possible.
What follows is a basic guide to drawing down your savings in retirement.
•Use the “4% rule” as a benchmark. The 4% rule, based on early-1990s research, holds that a retiree with a balanced (stock-and-bond-mix) portfolio could safely pull out 4% in the first year of retirement — then that same dollar amount each subsequent year plus an inflation adjustment.
That was considered a safe formula because, based on historical market performance, withdrawals at the 4%-rule rate wouldn’t exhaust the portfolio even after 30 years.
Stocks worldwide were hammered at the start of 2016 by fears that the global economy was slowing far more than expected, led by China. Another dive in commodity prices, including oil, also unnerved stock investors -- while driving government bond yields down. But some surprisingly strong U.S. economic reports in February bolstered confidence, and equity markets began to bounce. A rebound in oil prices also helped. So did the Federal Reserve’s decision to delay further interest rate hikes. The final tally: Most bond investments rose in the quarter, while stocks worldwide were a mixed bag -- with the U.S. again the best place to be. Here’s a look at how 15 key investment sectors fared in the quarter:(Richard Drew / Associated Press)
The Dow Jones industrial average and the Standard & Poor’s 500 both recouped deep dives in the first quarter to close slightly higher. The Dow ended up 1.5% to 17,685.09. The S&P edged up 0.8% to 2,059.74. The average blue chip stock mutual fund gained 0.3%, according to Morningstar. As the Federal Reserve backed off from further interest rate increases, at least temporarily, the U.S. dollar fell against many foreign currencies. That helped boost optimism about U.S. multinational companies, whose sales and earnings were hurt last year by the strong dollar. The Fed’s rate patience also helped fuel a major rally in dividend-paying stocks -- like wireless telecom giant Verizon Communications. Its stock was up 16.8% this year through Friday, the best gain of any Dow stock.(John Minchillo / Associated Press)
Midsize stocks once again were the market sweet spot, with the Standard & Poor’s 400 index rising 3.3% in the first quarter, beating the 0.8% gain of the blue-chip S&P 500 and the 2.3% advance of the S&P 600 small-stock index. Some investors prefer midsize stocks because the firms have outgrown small-company territory and could be on their way to large-company status. One of the biggest midsize gainers in the quarter was Domino’s Pizza. The firm’s stock is up 20% year-to-date, underpinned by better-than-expected sales and earnings. Domino’s raised its dividend 23% in February.(Douglas C. Pizac / Associated Press)
Small-company stocks rebounded with bigger shares after the market’s January swoon, but the two main small-stock indexes diverged. The Standard & Poor’s 600 was up 2.3% in the quarter, but the broader Russell 2000 lost 1.9%. The average small-stock mutual fund rose 0.5%, according to Morningstar. Weakness in biotech stocks and in financial stocks hurt the Russell index in the quarter. Bank stocks lost ground after the Federal Reserve decided against raising interest rates further in the quarter. Higher Fed rates help banks because they typically raise their loan rates faster than their deposit rates. Shares of Los Angeles-based Hanmi Financial dropped 7.2% in the quarter.
(Cheryl A. Guerrero / Los Angeles Times)
Weakness in some big-name technology stocks and in the biotech sector kept the Nasdaq composite index in the red in the first quarter, despite a mid-winter rebound. The Nasdaq lost 2.7% in the three months, compared with a 0.8% gain for the S&P 500. The average biotech stock is down 20% year-to-date, leading a broad pullback in the health care sector. Nasdaq also was held back by Amazon, which is down 11% this year after rocketing 118% last year.(Jonathan Alcorn / AFP/Getty Images)
Yields on many cash accounts edged up in the quarter but remained close to zero, after the Federal Reserve’s initial 0.25-point rate hike in December. The average annualized yield on money market mutual funds was 0.11% this week, according to iMoneyNet. That was up slightly from 0.02% at year-end. The average yield on one-year bank certificates of deposit nationwide now is 0.28%, up from 0.27% at year-end, according to Bankrate.com. Many banks are flush with deposits and are in no hurry to boost rates paid to savers.
(Larry Gilpin / Getty Images)
A fresh scare about slowing global economic growth triggered another rush of money into government bonds worldwide in the first quarter, as investors sought safety. That drove bond yields sharply lower. The yield on the benchmark 10-year U.S. Treasury note fell as low as 1.53% in February from 2.31% at year-end. The yield closed Friday at 1.77%. The drop in yields pushed bond prices higher, produced hefty “total” returns (interest plus price appreciation). The average mutual fund that owns long-term U.S. bonds soared 7.3% in the quarter -- trouncing returns on most U.S. stocks, according to Morningstar.(J. David Ake / Associated Press)
Yields on many high-quality corporate bonds fell with government bond yields in the quartet as nervous investors sought safety. It also helped that the Federal Reserve held back from raising short-term rates after its December hike. The average high-quality corporate bond fund generated a total return (interest plus principal appreciation) of 3.6% in the quarter, according to Morningstar. The junk bond market was a different story: Economic jitters caused the average junk yield to surge above 10% in the quarter, before retreating to end at about 8.4% -- down from 8.8% at the start of the year. Mostly based on interest earnings alone, the average junk bond fund was up 2.1% in the three months.
Tax-free municipal bonds have been a haven from turmoil in other markets over the last year. That continued in the first quarter, as the finances of many state and local governments continued to improve -- despite some high-profile trouble spots, such as Illinois and Puerto Rico. The average mutual fund that owns long-term California muni bonds posted a total return of 1.8% in the quarter, after 3.6% gain in 2015. Because muni interest is tax exempt the true return is higher.(Marcus Yam / Los Angeles Times)
Popular among many 401(k) savings plan investors, target-date retirement mutual funds promise to maintain a mix of stocks and bonds that will automatically tilt toward more bonds -- and, in theory, less risk -- as the investor’s retirement date nears. And by staying diversified, the funds avoid the volatility that investors can suffer if they’re solely in stocks or solely in bonds. In the first quarter every target-date fund category tracked by Morningstar produced positive returns, as gains on bonds boosted overall results. The average returns ranged from 1.8% on the 2000-2010 funds to 0.2% in the 2051-plus funds.
(Thomas Barwick / Getty Images)
European stocks bounced back from their worst levels of the quarter, but the average European stock mutual fund still lost 2.5% in the three months, according to Morningstar. The funds were lower even though the dollar fell against the euro, which helped U.S. investors’ returns. Global investors remain suspicious of European shares even though the European Central Bank is pouring more stimulus into financial markets -- including fostering negative yields on European government bonds.(Philip Lee Harvey / Getty Images)
Asian stock markets were broadly lower in the quarter, failing to bounce back as quickly as Wall Street. Investors remained spooked by China’s economic slowdown -- and, more recently, by fears that Japan’s economy is worsening. The average mutual fund that owns Chinese shares fell 4.7% in the quarter, though in the last month it was up 9.7%, according to Morningstar. The average Japanese fund was off 3.6% in the quarter.(ChinaFotoPress / Getty Images)
The average emerging-market stock mutual fund turned positive in the first quarter, posting a 3.9% gain, according to Morningstar. That followed a 13% plunge in 2015, as plummeting commodity prices hammered many developing economies. The first quarter turnaround was led by Latin American stocks. Funds that own only Latin American shares soared 14.7% in the three months -- after crashing 29% last year. A weaker dollar has helped U.S. investors’ returns this year. But whether the bottom has been reached in emerging markets remains to be seen.(Alexandre Meneghini / Associated Press)
Gold staged a strong rally in the first quarter as its archrival, the U.S. dollar, weakened. The price of gold was $1,224 per ounce as of Friday, up 14% year-to-date. Commodity prices in general bounced off their lows in the quarter, after being pummeled last year by weakening global demand. Crude oil ended Friday at $36.63 per barrel, up from a low of $29.85 in January. But it still isn’t clear that the bottom has been reached in commodities.(Getty Images)
For years, the health care sector has been a stock market leader. But sentiment began to sour on the stocks in the second half of last year. That continued in the first quarter, when the average mutual fund that focuses on health care slumped 13.4%, according to Morningstar. One issue has been rising political criticism of pricing of new drugs, particularly from the biotech sector. The average biotech stock is down 20% this year.
(Rafe Swan / Associated Press)
Normally staid utility stocks rocketed in the first quarter, benefiting from many investors’ appetite for dividend-paying shares considered to be relative havens. The average utility-focused stock mutual fund surged 11.2% in the three months, according to Morningstar, compared with a mere 0.8% gain for the average blue chip stock. But many analysts warn that utility stocks have become pricey after their powerful advance.(Charlie Riedel / Associated Press)
The question now, however, is whether future market returns will be much lower than historical returns. Over the last 30 years, for example, long-term U.S. government bonds have posted an average annualized return of 8.3% a year, counting interest and appreciation, according to Morningstar Inc. But with 10-year Treasury notes now yielding about 1.8%, replicating that 30-year performance is virtually a mathematical impossibility.
If your retirement funds earn less than you assume, you’ll need to reduce withdrawals over time or risk running dry sooner.
Yet many financial advisors still are willing to begin the discussion at 4%, even if the final number is lower. “It’s still a reasonable starting point,” said Christine Benz, director of personal finance at Morningstar in Chicago.
A retiree with a $400,000 nest egg, then, would plan to take out a maximum of $16,000 the first year for living expenses.
•Build a retirement financial plan around your withdrawal rate. Your savings are one source of income in retirement. For most people, Social Security is the other main source. (Your benefits are easy to calculate online.) If you’re willing and able to work part-time, that could be another cash generator.
Some people also can count on corporate pensions. Although they have been disappearing rapidly over the last 30 years, there still was $3.09 trillion in pension plans covering private-sector workers as of 2013. But that was dwarfed by the combined $11.56 trillion in 401(k)-style savings plans and individual retirement accounts.
Free online simulators can help you calculate future income. But because there are a lot of moving parts involved, it’s ideal to seek help from a professional financial advisor at this stage of your planning. If you’re worried an advisor might try to sell you stuff, go with a fee-only planner.
“This is important stuff,” Benz said. “So even if you’ve been a dedicated do-it-yourselfer until now, it helps to have another set of eyeballs on it.”
A key consideration is what kind of lifestyle you envision in retirement or semi-retirement.
Gary Noreen, who retired as a systems architect at Jet Propulsion Labs in 2010 and lives in Oxnard, said he drew inspiration early on from his parents, who successfully planned and saved for a comfortable retirement.
“They’re in their 90s now,” said Noreen, 62. “I asked myself, ‘If I live to 95, how much do I need to live like they do?’” That influenced his own aggressive investing well before he retired. “I saw that I could do it,” he said.
•Your spending is a wild card. Just as you have flexibility in terms of when you draw income in retirement, you have flexibility in spending on everything that is nonessential.
Many advisors say it makes sense to expect that you’ll spend more in the first years of retirement — when you’re still mobile — and then assume expenses for things like travel will drop later in life.
“We break out the client’s life into different spans,” said Sandi Bragar, a principal at wealth management firm Aspiriant in San Francisco. Typically, she said, “we find spending will increase during the initial period of retirement.” Nervous clients may reject that idea, she said, “but it might be the right thing to do if they’re healthy” and want to enjoy life.
A survey by the Employee Benefit Research Institute early this year found that retirees are more likely to underestimate spending than overestimate it. A total of 38% of retirees in the survey said their expenses were higher than they expected, while 21% said they’ve spent less than expected.
•Think about which accounts to tap first for retirement income, and realize that conventional wisdom might not apply to you.
Retirees usually are advised to spend down their taxable assets first (i.e., assets not held in tax-sheltered accounts), then their 401(k) and conventional IRA assets, and finally non-taxable Roth IRA accounts. They’re also often advised to defer taking Social Security for as long as possible, to get a bigger benefit.
But a different formula may be better for you, particularly when it comes to taxes. The goal, Benz notes, “is to stay in the lowest possible tax bracket” each year, and thereby make your entire asset pool last as long as possible. That could entail taking money annually out of each of your accounts, to engineer the least painful tax bite. Converting conventional IRAs to Roths also is a common strategy.
Likewise, some retirees calculate that they’re better off taking Social Security earlier than later. Noreen is taking his benefit now, he said, because “if I waited till 70 I would have to take money out of my IRAs in the meantime. This way I can leave it there to grow.” He’s betting he will earn more on his IRA investments than he would by waiting for a larger Social Security benefit.
The argument for waiting is that the higher Social Security payment becomes a kind longevity insurance if you outlive your money, maximizing your benefit.
•Factor in the withdrawals Uncle Sam will force you to take. Retirees who have accumulated significant nest eggs must keep in mind the “required minimum distributions” they’ll face at age 701/2.
The government mandates that you begin drawing from conventional IRAs, 401(k) plans, 403(b) plans and similar tax-deferred programs once you turn 701/2. The minimum withdrawal each year is determined by average life expectancy as the IRS calculates it.
Fred Wallace, a 61-year-old retiree in Playa del Rey, expects to have pension income next year from his former employer, and Social Security income in three years. He’s already thinking ahead to the minimum withdrawals he’ll face later on his IRAs. “I’m very mindful of tax brackets,” he said. That may lead him to rethink how and when he’ll tap his various income options, he said.
Thinking about taxes is helpful in another way, Wallace said: You’ll realize that you won’t have as much to spend in the future as your gross savings suggest. After figuring federal and state tax, “It’s not worth what it seems,” he notes.
•Consider annuities and reverse mortgages. Both of these income options historically have had poor reputations among financial advisors. That may be changing.
Annuities are insurance contracts that can guarantee you a specific amount of income every year for the rest of your life. You typically buy them by paying an insurer a lump sum upfront. Essentially, the insurer is betting that it can earn more on the payments it receives than it eventually pays out. If you die relatively young, for example, you might lose; it’s the risk you take.
The knock on annuities has long been their often high sales commissions and management fees. Even so, with millions of retirees at risk of running out of money before they die, “As much as I hate annuities, the reality is there may be a bigger place for them than we previously thought,” said Bob Klosterman, founder of White Oaks Wealth Advisors in Minneapolis.
Larry Siegel, research director at the CFA Research Institute Foundation in Charlottesville, Va., suggests a strategy that centers on buying a deferred annuity at age 65 that would begin paying you at 85. From 65 to 85, you’d live off the rest of your savings. By having the annuity in place at 85, you avoid the worst-case scenario of outliving your money.
“I’ve become a big fan of these as a retirement-income tool,” said Wade Pfau, professor of retirement income at the American College of Financial Services in Bryn Mawr, Pa. But he said it’s imperative that homeowners do substantial comparison shopping. In his own research, Pfau said, he found reverse-mortgage upfront fees of as little as zero — and as much as $10,000.