Retirement Income Part 1: Why Most Retirees Will Never Draw Down Their Savings
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm kicking off a multi-part series on creating a reliable income stream in retirement. To help set the stage for this series, Michael Kitsis drops in to share why most retirees will never draw down their portfolio. In fact, he shares how the 4% rule is more likely to quintuple wealth than deplete it over a 30-year time period.

For all the links and resources mentioned today, head over to youstaywealthy.com/121 Approximately 50% of Americans worry that they will outlive their retirement savings. And according to an Allianz study, 77% of people in their late 40s said that they were more worried about running out of money in retirement than dying. And that number crept up to 82% for those with dependents.

Running out of money is without question the single biggest fear for retirement savers. And while 40% of Americans have less than $5,000 in retirement savings and have a great reason to be worried about running out of money, this fear still exists for wealthy retirement savers. They might have more money, but they likely also spend more money and or have higher expenses. It's all relative.

Worry, concern, and stress about money is a real thing. In fact, the technical term for the fear of money is chromatophobia. Symptoms include an extreme hesitance to think about money, withdrawal from activities because you're worried about money, a frequent desire to check account balances, depressive thoughts, and even the refusal to literally touch and handle physical money.

At first, those symptoms might sound a bit extreme, but give it some thought and I'm willing to bet that we can all relate to at least one of them. In fact, giving our affluent clients the confidence to spend the money that they worked so hard to save is one of the most common challenges that we face. You can show a person all the math and spreadsheets in the world to give them the confidence to spend more money and enjoy life in retirement, but it rarely makes a difference.

As I've shared many times on this show, our attitudes and behaviors towards money begin at a very young age. Some suggest as early as age six or seven. In other words, how we act towards money today has a lot to do with our experiences and teachings from 30, 40, maybe even 70 years ago. And retraining these hardwired habits and behaviors later on in life is not an easy feat.

Going from being a good saver and a conscious spender and watching your savings grow and grow to retiring and traveling around the world and spending down your account balances is a major life transition that many people underestimate. All of this makes the topic of today's conversation even more fascinating. And that is the fact that according to friend and fellow financial planning nerd Michael Kitsis, most retirees will never draw down their retirement savings.

And the chance you don't know Michael, he's the chief financial planning nerd for Kitsis.com, which publishes research on financial planning and retirement planning and is the leading blog for financial advisors. He's also the head of planning strategy for Buckingham Strategic Wealth. Michael wrote one of my favorite articles on the dynamics of spending down our retirement savings, and he was kind enough to drop in today to share some of his thoughts and findings.

So a few years ago, a research paper came out that lamented how retirees were underspending their retirement portfolios. I know for a lot of people, we just hope to accumulate enough dollars to be able to retire. But they found that there was a phenomenon where often some of the people who have been most successful at saving for retirement actually became so good at saving and managing their spending that when they retired and it became time to spend, they were having trouble spending their own retirement dollars.

And so over the first decade or so of their retirement, their portfolios were actually equal or larger to when they started. And the researchers labeled this a retiree consumption gap. But in practice, retirement spending isn't quite so simple as saying, well, let's spend down our retirement savings during our retirement. In part, it's because we don't know how long retirement will actually be.

Especially in early retirement, where it just seems like a long time when you've stopped working and you're living day to day and week to week and realize there is a lot of time, a lot of years ahead of us in retirement, and there isn't going to be any more employment income coming in. Whatever we've got, this is it. This is everything we've got. It tends to make us naturally feel a little bit conservative about holding on to what we've got.

Now, the other challenge around spending down retirement savings in retirement is simply that phenomenon of inflation. Things get more expensive as time goes by. Now, in general, inflation has been modest, at least for the past several decades. But when you're planning out for a 30-plus year retirement, that adds up.

At 2% inflation, the price of everything almost doubles over the span of 30 years. At 3%, it's up almost 2.5x. At 4%, it's more than triple. So just to put that in context, if you're looking to live an $80,000 lifestyle in retirement, that's going to be almost $150,000 a year 30 years from now just to maintain that $80,000 lifestyle given how much more expensive everything will be.

If inflation turns out to be 3%, that's a $200,000 a year lifestyle just to buy the things you're buying today with how much more expensive they become over 30 years. And what that means is even if you want to spend all of your retirement savings in retirement, in the first part of retirement, you actually have to build up the balance at least a little bit for just the mathematics of how expensive everything gets later.

In fact, if you do the math, a normal plan where you plan to spend everything over a 30-year retirement, we have done the math and figured out exactly how much you can spend to use up all of your savings after 30 years.

your portfolio of savings would still grow in the first decade. In fact, you wouldn't even touch any of the original principal until nearly the end of the second decade. And only in the final 10 years of retirement would you use most of the original nest egg to do those final years of very high inflation-adjusted spending.

And if you're concerned that returns might be a little bit lower, that inflation might be a little bit higher in today's environment, it would lead you to spend even less early on. Not because we're somehow mentally failing to enjoy our own retirement savings, but simply because that's how it's supposed to work. That's the mathematics of retirement with long time horizons and the pernicious effect of inflation.

Now, the other challenge, of course, is that in the end, we almost never actually really spend it all down. Because even with the mathematics of growth and inflation over long retirement time periods, we never really quite know exactly what that time period is going to be. Because we don't know when the end is coming. Classically speaking, the ideal retirement plan is to die broke. If you do it perfectly, the last check you write is to your undertaker and it bounces.

But in practice, it's almost impossible because we don't actually know when that time is coming. We always have to have a little bit left in reserve just in case we're still going a few more years or maybe a lot more in reserve if we're concerned we might still go a lot more years. You know, we lived this in our family as my grandmother lived to be 101 years old.

We actually see this today with the growth of alternative strategies, I would call it, for how to generate spending dollars in retirement. Things like the 4% rule, which says we're simply going to start out spending 4% of our initial retirement savings, and then we're going to adjust that dollar amount up each year for inflation. So that even if market returns don't go well, we know historically that starting at that 4% spending level is sustained even through horrible environments like the stagflationary 1970s and the Great Depression.

But again, the challenge of those conservative spending strategies is it often drives a lot of upside in the end. For as popular as the 4% rule has been in the media lately, what people often don't realize is that the 4% rule actually doubles your nest egg more than two-thirds of the time.

So in other words, two out of every three times, not only do you not use your retirement savings, you leave double the nest egg without ever actually having gotten around to using it. In fact, the 4% rule is as likely to quintuple your starting wealth as it is to have you finish with less than you started, which is leading to newer approaches to retirement planning, most popularly called either floor and ceiling or guardrails approaches.

I have young children, so occasionally we take them out bowling. And for those who have been over the years bowling for young children, we have guardrails, right? We have little bumpers that come up.

up that keep the ball from rolling into the gutters on either side. And so when my daughter goes up to roll the ball at any particular time, one of two things happens. Either she rolls it fairly straight down the lane, it rolls down to the end, hits the pins, and she does her celebratory dance. Or she rolls it slightly askew, it drifts off to the side, heads towards the gutter, but it hits the bumper, bounces off the bumper, goes back in the middle lane, hits the pins at the end. She is equally happy either way. She doesn't really care about whether or not we happen to bump off the bumpers along the way.

She just wants to make sure that it's a successful run to the end at every time.

And we can do the same thing with retirement portfolios. So rather than arbitrarily saying we're going to spend this much or that much, we try to make it a little bit more dynamic. But say, let's keep within the guardrails. Okay, maybe we'll start out spending 5% of our portfolio, but we'll put guardrails on. As long as our spending stays somewhere between 4% and 6% through the first half of retirement, we know we're on track. And so if markets are good, we'll get to lift our spending up. If markets are more challenging, we may have to trim it back a little bit.

But rather than blindly saying, well, let's just see what happens and we'll finish with extra along the way, we can actually make adjustments along the way.

The key point to all of this, though, is to simply recognize that in practice, it is perhaps unfortunately truly difficult to ever actually spend down our retirement savings in retirement, even if we want to, because we don't know how long retirement will be. And the more conservative we are about the uncertainty of how long we'll live, the more inflation adds up over time and drives that mathematical reality that you should be spending less than your growth in the early years of retirement.

That's just the mathematics of how prudent retirement planning works when this is your only nest egg for retirement, and it might have to last 20, 30 years or more.

Okay, a big thank you to Michael Kitsis for dropping in today and sharing his thoughts with us. While his blog is written and intended for financial planners, a lot of the nerdy financial planning topics that he writes about, like the one we're talking about today, are helpful and of interest to retirement savers like you who enjoy learning about this stuff. So I'll link to his blog and the article he wrote about today's topic in the show notes, which again, you can find by going to youstaywealthy.com forward slash 121.

So there were three things that Michael said that really jumped out to me that I think are important to highlight. The first is this idea of the consumption gap. And it's just fascinating to me that not only are retirees not spending all of the income available to them, but their spending actually begins to decline in retirement. And as a result from 2000 to 2008, when this research was done during that time period, market returns were low and should have put a lot of pressure on retirement portfolios.

the average financial assets of wealthy retirees during that time still continued to increase. In addition to maybe giving yourself permission to spend more money in retirement, this research around the consumption gap further reinforces, at least in my opinion, how important it is to have a legacy plan, i.e. a plan for your money when you're no longer around.

While I hear many people say, "Well, I'll just give my kids whatever's left at the end," having a documented legacy plan allows you to potentially set things up for your heirs to inherit in a more tax-efficient manner and potentially provide you with some tax breaks while you're still alive. The second thing to highlight is Michael's comments on inflation. Inflation is all the buzz right now and many of the so-called experts are making headlines by suggesting that high inflation is right around the corner.

Even if we don't see giant inflation numbers, because that's really anyone's guess. I mean, we can make educated predictions, but we don't know exactly what's around the corner. So even if we don't see giant inflation numbers, his comments and examples were a great reminder how even a small change to inflation can dramatically impact your spending needs in retirement. So in addition to planning appropriately for inflation, which I've talked about before in the podcast,

Knowing the impact inflation can have on your plan will likely also influence how you invest your money as well. Putting all of your money in bonds or cash under the mattress will likely just be losing money to rising prices every single day. So we have to be incredibly thoughtful about our asset allocation in retirement if we want to maximize our income and combat inflation, all without losing sleep every night, worried that we're going to run out of money, or worried that the stock market's going to go to zero.

As I've shared before on the podcast, most financial advisors like talking about risk tolerance, which is the amount of risk that you're comfortable accepting without panicking and losing sleep. But risk capacity is just as important, maybe even more important. And that is how much risk do you need to take to reach your goals? A lot of factors go into figuring out your risk capacity and inflation assumptions are certainly one of them.

The last thing that Michael mentioned that always surprises people is the, were the statistics around the 4% rule. The first was that retirees and the analysis he shared finished with more than double their starting wealth in two thirds of the scenarios. And the second was that the 4% rule was more likely to quintuple your wealth than deplete it after a 30 year time period.

It's been said time and time again, both on this podcast and off, that the 4% rule is far from perfect. To me, it's a good starting point for the retirement income conversation, a back of the napkin approach to checking in with where you're currently at in your retirement savings journey. Remember, the 4% rule is built for environments that have terrible returns in the first part of someone's retirement.

if you use long-term average returns of the markets, the quote safe withdrawal rate would actually be well over 6%.

Given that predicting the timing of a future bad environment is literally impossible, many, including myself, argue that using a dynamic withdrawal strategy, like Kitsis mentioned, one of them is known as guardrails or floor and ceiling, using a dynamic withdrawal strategy is more prudent. And that's what we're going to be getting into during the rest of this series, the different retirement income strategies to choose from, how they work, the pros and cons of each,

how your investment portfolio plays into that retirement income strategy and why a systematic rules-based system is likely more important than anything else.

For all the links and resources mentioned today, head over to youstaywealthy.com forward slash 121. Thank you as always for listening, and I will see you back here next week. This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.