Why You Won't Run Out of Money in Retirement
One prominent retirement fear is outliving your retirement savings. But this common concern seldom happens, because there are plenty of ways to adjust your spending and tighten your belt when the markets take a dive. Here's why you aren't likely to completely run out of money in retirement.
Spending has been going up and down all your life. No one actually spends a constant amount adjusted for inflation every year. You sometimes get big expense years, such as when you decide to change your car. Other years, you are too busy to take a vacation and you naturally spend less. Spending will fluctuate, which means you can easily tighten and loosen your purse strings as long as you pay attention.
Some types of expenses may decrease during market panics. An economic decline may cause some things to drop in price. For example, many types of home repairs cost less during the financial crisis. There wasn't enough work to go around and prices fell. Traveling was also much cheaper than usual for a few years. A general decline in prices can work wonders for retirees on a fixed income because their expenses will decrease even if they don't do anything to change their lifestyle.
Some of your expenses will decline over time. Some expenses decrease due to new products introduced into the marketplace. For example, technology often becomes cheaper once an innovation is a few years old. If you are willing to put in a little time, you can also find other ways to save money on essential services. Sometimes spending less simply means avoiding new products that you have never tried before. This isn't nearly as bad as having to give up services you are already accustomed to.
Social Security is adjusted for inflation. Social Security provides an income floor for almost every older person in our country. For example, let's say you retired and an event along the lines of the great recession happens again, wiping out half your equity values. If your asset allocation is 60 percent stocks and 40 percent bonds, you might lose 30 percent of your portfolio value. Now, let's assume that 35 percent of your spending is covered by Social Security. Since Social Security doesn't get cut when the markets dive, you just need to cut 30 percent from the portion of income that comes from your investments, which is actually only a 19.5 percent pay cut. A 19.5 percent drop in spending power is still drastic, but it's manageable due to the unwavering income you receive from Social Security. Plus, delaying big purchases and trips for a year or two is likely to help you make significant progress spending less until your investments have time to recover.
You can get an annuity, even at an advanced age. If you are certain you never want to reduce your expenses in retirement, you can purchase an annuity that provides another guaranteed stream of income. For example, let's say you are 80 and your portfolio is only worth a fraction of what it was worth when you retired. You could use your savings to purchase an immediate annuity that will provide monthly payments for the rest of your life. If you only annuitize a small amount of savings, the payments might not be large, but they can be set up to continue for as long as you live and won't decline due to stock market drops.
Safe withdrawal rates are calculated to survive the worst. An annual withdrawal rate of 3 or 4 percent of your savings each year has been calculated to survive the worst stock market period in history. Your retirement could span several decades, and there will probably be declines during that period. No one knows what stock valuations and interest rates will be 10 or 15 years from now. But a conservative withdrawal rate and some cutbacks in spending during years in which the market performs especially poorly is likely to allow your money to last for the rest of your life.
You need to live a long life for your money to run out. While we all like to think we will live until age 100, few of us do. While there's certainly the possibility that you will outlive your portfolio assets, you can always cut your expenses or adjust your spending to account for what turns out to be an exceptionally long life span. Plus, you will still have Social Security payments coming in, so you are looking at a very small chance that your money will ever completely run out.
David Ning is the founder of MoneyNing.com.