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Meet the "Spend Safely in Retirement" strategy

How to retire early
How "super savers" can reach financial independence and retire early 04:02

How will ordinary workers retire in a world that no longer offers traditional pensions for most? How will they decide if they have enough savings to afford retirement? And how can they generate reliable, lifetime retirement income?

These questions pose serious challenges for older workers approaching their retirement years -- especially now because the switch from traditional pension plans to 401(k) plans has placed a serious responsibility on them. They need to be their own investment managers and actuaries, and they have to decide how to best deploy their savings in retirement. It should surprise nobody that most workers don't have the skills needed to successfully answer these questions.

To address this problem, many articles suggest you consult a financial planner. But finding an adviser who is both skilled with retirement income planning and isn't conflicted by how he or she is paid can be a roadblock for many workers. And not many people take this advice: Only about one-third of workers contact advisers for any purpose.  

Without anyone to consult, just about half of older workers attempt to calculate how much money they need to retire. In fact, the "planning" that most older workers complete is to estimate their monthly retirement income, then reduce their living expenses to that level.

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When it comes to deploying their retirement savings, retirees tend to exhibit two distinct strategies:

  1. Conserving savings for a rainy day, minimizing their withdrawals and treating savings as an emergency fund.
  2. "Winging it" by treating their savings like a checking account to pay for current living expenses, often withdrawing too rapidly at an unsustainable rate.

Neither strategy seems optimal. Better for the first group would be a plan that enables them to spend more in retirement and feel safe. The second group needs to spend their savings more safely, so they won't outlive their money.

Needed: Straightforward retirement income solutions

Older workers have a clear need to generate reliable, lifetime retirement income -- or to "pensionize" their IRAs and 401(k) accounts. This would enable middle-income workers to more easily complete the necessary, even if rudimentary, retirement planning.

The good news? Recent research by the Stanford Center on Longevity (SCL), collaborating with the Society of Actuaries (SOA), identifies a straightforward retirement strategy that can work for most middle-income retirees and be implemented in virtually any traditional IRA or 401(k) plan.

This research provides a framework for assessing different retirement income generators (RIGs) and navigating the many trade-offs older workers face when making retirement income decisions. It compared 292 different retirement income strategies, including various combinations of Social Security claiming ages, systematic withdrawals from invested assets and annuities from insurance companies.

For three hypothetical retirees, this research prepared "stochastic forecasts" and "efficient frontiers," analytical techniques that many large pension plans use to devise funding and investment strategies.

Introducing "Spend Safely in Retirement" 

The SCL/SOA report identifies the "Spend Safely in Retirement" strategy, which produces a reasonable trade-off among various goals for middle-income retirees. This strategy delays Social Security for as long as possible but no later than age 70 for the primary wage-earner, and it takes advantage of Social Security's many desirable features

The "Spend Safely in Retirement" strategy recommends that retirees invest their savings in a low-cost mutual fund and use the IRS required minimum distribution (RMD) to calculate the lifetime retirement income those savings will generate. The SCL/SOA report suggests using low-cost target-date funds, balanced funds or stock index funds for this purpose.

The IRS RMD rules dictate the minimum withdrawal starting at age 70-1/2, which is 3.65 percent of savings at that age. The SCL/SOA analyses assumed a withdrawal percentage of 3.5 percent from ages 65 to 70.

The best way for an older worker to implement the "Spend Safely in Retirement" strategy is to work just enough to pay for living expenses until age 70 in order to enable delaying Social Security benefits. In essence, "age 70 is the new 65." To make this method work, retirees may also need to significantly reduce their living expenses.

If a worker isn't willing or able to delay retirement, the next best way to implement the "Spend Safely in Retirement" strategy is to use a portion of savings to enable delaying Social Security benefits as long as possible but no later than age 70.

Benefits of "Spend Safely in Retirement" 

The SCL/SOA analyses show the "Spend Safely in Retirement" strategy has many key advantages:

  • It produces more expected total average retirement income throughout retirement compared to most other solutions the SCL/SOA report analyzed.
  • It automatically adjusts the withdrawal amounts to recognize investment gains or losses. Withdrawals are increased after any year with a favorable return but decrease after an unfavorable return.
  • It provides a lifetime income, no matter how long the participant lives, and it automatically adjusts the withdrawal each year for remaining life expectancy.
  • It projects total income that increases moderately in real terms, while many other solutions aren't projected to keep up with inflation.
  • It produces a moderate level of accessible wealth for flexibility and the ability to make future changes. It also provides a moderate level of bequests, for the same reasons listed above.
  • It produces low measures of downside volatility.
  • It gives older workers the flexibility to transition from full-time work to part-time work to full retirement.

The "Spend Safely in Retirement" strategy has another significant advantage: It can be readily implemented from virtually any IRA or 401(k) plan without purchasing an annuity. Many administrators can calculate the RMD and automatically pay it according to the frequency elected by the retiree.

Helping with important life decisions

The "Spend Safely in Retirement" strategy represents a straightforward way for middle-income workers with between $100,000 and $1 million in savings to generate a stream of lifetime retirement income without purchasing an annuity and without significant involvement from financial advisers. This group might represent as many as half of all workers age 55 and older.

This strategy can also help older workers make important life decisions, such as how long they should continue to work full-time, whether they should transition into retirement with part-time work, when they can fully retire and how much money they can spend in retirement. 

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