Safe Withdrawal Rates: How Much Can You Safely Spend?

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney

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Safe Withdrawal Rates: How Much Can You Safely Spend?
Jim Lange, CPA/Attorney
Guest: Bill Bengen, Certified Financial Planner
Episode 41

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TOPICS COVERED:

  1. Introduction of Special Guest, Bill Bengen, CFP
  2. Defining the Safe Withdrawal Rate
  3. Different Withdrawal Rates for Different Life Expectancies
  4. Caller Q&A
  5. Safe Withdrawal Rates from Taxable Accounts, i.e., IRAs
  6. Safe Withdrawal Rates from Fixed Retirement Accounts
  7. Three Stages of Retirement

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.

Nicole: Hello, and welcome to The Lange Money Hour, Where Smart Money Talks.  I’m your host Nicole DeMartino, and of course, I’m here with Jim Lange, CPA/Attorney and best-selling author of Retire Secure! and his new book, The Roth Revolution: Pay Taxes Once and Never Again, which is now available on Amazon.com.  Tonight, we’re getting right into it.  We’re talking tonight about safe withdrawal rates, and simply put, that means how much can you safely spend out of your retirement plan and not run out of money.  This is a question that Jim gets all of the time, and we felt that it was a good time to talk about this on the show.  It’s crucial to determine this number correctly, because if you don’t, you could be in some big trouble.  Tonight’s show is live.  The studio line is 412-333-9385 and the lines are open right now, so before I turn it over to Jim, I want to introduce everyone to our guest tonight, who is going to help us answer that question, how much you can spend without running out of money. 


1. Introduction of Special Guest - Bill Bengen, CFP

Now tonight, we actually have a surprise guest.  He’s such a surprise, it was even a surprise to me when I came into the studio.  Since yesterday was Election Day, Jim wanted to do a show on how taxpayers should respond to yesterday’s election.  But his goal is not to do a political show discussing politics, but rather, a practical show on what listeners should be doing in terms of tax planning and estate planning, in other words, what you should be doing in response to the election.  So, for our guest tonight, our surprise guest, Jim was lucky enough to find Dr. Gerry Shuster, who teaches Political Communications at the University of Pittsburgh.  Gerry earned his PhD from the University of Pittsburgh, and he is regularly quoted by the media on various topics related to local, regional and national political issues and events.  So, Gerry, are you there?

Bill:   I certainly am.  It’s great to be here.

Nicole:   Alright, well, thank you for joining us. 

Jim:   Before we get into this substance, I just thought I would mention how I invited Bill to come on the radio show.  In the 90’s, there was an article on the safe withdrawal rates in the Journal of Financial Planning, and I was so impressed with the article that I literally tore it out of the magazine and I kept it for years and referred back to it on numerous occasions, and then, when I decided to do a show on the safe withdrawal rate, I did an independent examination.  I went into Google and other sources, and I was looking for who was writing in this field in an authoritative way, and guess what?  It was the same guy, Bill Bengen.  So Bill, I very much appreciate you being willing to come on the show tonight, so welcome.

Bill:   Glad to be here.

Jim:   Alright, well, why don’t we get right into it?  By the way, I will also say that one of the benefits for me in terms of professional development of doing this show is I usually do read the book of the guest, and I have read your book and I have learned  a lot.  So, I will thank you there.  Could you explain to our audience the difference between the safe withdrawal rate and the expected rate of return over time?


2. Defining The Safe Withdrawal Rate

Bill:   Sure.  I know that when I first started doing this research, people used to calculate how much they could take out of their retirement portfolios without running out of money.  They used to say, “Well, I can earn seven or eight percent a year, and therefore, I should be able to take out seven or eight percent a year, and therefore, my portfolio should sustain me for the rest of my life.”  Well, unfortunately, there are two big things they forgot.  First of all, there’s inflation.  You have to take that into account.  Then, every once in a while, we run into a big problem with the stock market.  We did in 2008, where you have huge negative returns, and they can just decimate your portfolio for a period of time.  So what I went about to seek was taking all those factors into account, what is the highest rate of return that you could take out safely without running out of money for, let’s say, thirty or thirty-five years, and that’s where I came up with that four to four-and-a-half percent of your portfolio value figure. 

Jim:   Alright, and can you define ‘safely’ for our audience?

Bill:   Yeah, well, you know, safe is relative.  There are no guarantees in investing or anything else, but essentially, I look back over the last eighty years or so, going back to the Great Depression, and I created imaginary investors who retired at various dates and gave them their investment returns as they actually earned and actual rates of inflation, and I determined that the four or four-and-a-half percent worked in every single case, and all of those folks lasted for at least thirty years.  Their portfolio sustained them.  So, that’s what ‘safe’ means. 

Jim:   Alright.  So, basically, you’re saying a financial reconstruction of going back, based on historical data, in every single scenario, you came up with a, let’s say, four or four-and-a-half percent rate and nobody ran out of money.  Is that correct?

Bill:   That’s correct.  That’s right.

Jim:   Alright.  So, in your book you call, and I guess what we’re talking about is the safe withdrawal rate.  Is the safe withdrawal rate the same as safe max?

Bill:   Yes, yes.  They’re interchangeable, yeah.

Jim:   Alright, so, safe max is the name you give in your book for what you consider, again, you make a point, no guarantees, you’re not guaranteeing the future, so with that, let’s start with that thirty-year period.  You said between four and four-and-a-half percent, and let’s say, you have a million dollars.  That would mean that you could either take out $40,000 or $45,000 from the portfolio, and have that money last thirty years, and you can take out, let’s say, if it’s four percent, you could take out $40,000 and if it’s four-and-a-half percent, it’s $45,000.  Do you want to distinguish between four and four-and-a-half percent, or do you think that’s a reasonable enough relevant rate?

Bill:   I think the four-and-a-half percent is a good figure to use.  That’s when I updated my research and included other types of investments.  It went up to four-and-a-half percent.  I think that’s a reasonable figure to use.

Jim:   Alright, now, that’s an important point because there’s a big difference if somebody puts everything in CDs or if they put everything in the stock market or if they do something in between, and I know that you have different safe withdrawal recommendations for different years, but why don’t we just start with the base and talk about the thirty-year rate? 

Bill:   Okay.

Jim:   I mean, if I put it all in CDs, then inflation and taxes are going to eat me alive and I’m likely to run out of money.  Is that right?  In that case, four-and-a-half percent might be too high.

Bill:   That’s correct, particularly in today’s environment where our interest rates are artificially low, and may remain that way for a long time, CDs are going to be devastating for people. 

Jim:   So, what you’re really saying is it’s not necessarily safe to have a high percentage of your portfolios in CDs and fixed income if you want to have a higher safe withdrawal rate?

Bill:   That’s right.  In fact, what I found out, it’s dangerous to have a very high percentage of fixed income in your portfolio, and it’s equally dangerous to have a high percentage of stocks in your portfolio.  You need to have a blend, somewhere in between, for safety.

Jim:   Alright, and if we say that the goal is just to never run out of money for a thirty-year period, what does your research indicate the appropriate blend is?

Bill:   I think somewhere between fifty and fifty-five percent, equities, risk assets, whatever you want to call it and the rest in fixed income.  So, it might be 55% stocks and 45% bonds and money market funds would be a reasonable allocation to have.

Jim:   Alright, well, this is very helpful.  Let me ask you another question.  The famous article that you wrote, and I don’t know how many accolades you got from it, but I thought it was terrific, and I have seen it, particularly when I was doing the research to find you again, you know, just a lot of references to that article, so obviously, it was probably the most important article in its day, and I’m not sure that there’s a lot else that’s been written, but that was before 2008, and even your book is before 2008.

Bill:   That’s correct.

Jim:   Alright, well, you’re a bright guy.  You’re still in practice.  Has your opinion changed, and did the downturn make you think, “Oh geez, maybe I was going a little high,” or were you vindicated because other people who were saying higher safe withdrawal rates, their clients were running out of money and yours were okay?

Bill:   Well, I think the four-and-a-half percent withdrawal rate has stood the test of time since I introduced that in ’93 at four percent and raised it a few years later to four-and-a-half, and I think in this environment, you wouldn’t want to do any more.  I think it’d be extremely dangerous.  In fact, I’m not even sure if that is going to, quite frankly, you know, stand up if these market conditions and low interest rates continue for many more years.  We’ll have to see.

Jim:   Alright.  Now, let’s take a simple number, which is $1,000,000, because that’s a nice, easy number to remember, and let’s assume, for discussion’s sake, that we’re going to go by four-and-a-half percent.  So, let’s say that you retire on year one and you can take out $45,000.  How much money can you take out of year two?  Can you take out $45,000, or can you take out more, because there is inflation?

Bill:   Oh, you’re exactly right.  You want to take inflation into account.

Jim:   I can’t be right if I didn’t give you the answer (laughter).

Bill:   Okay.

Jim:   I’m sorry, Bill.  Go ahead.

Bill:   That’s quite alright.  The inflation needs to be taken into account.  It’s crucial that you do that.  What happens is, the first year you apply the four-and-a-half percent and come up with that $45,000 figure, but after the first year, you throw away that four-and-a-half percent and never worry about it again.  What you do is you take an inflation number, let’s say the inflation was 10% for the next year, well then you increase your withdrawals by 10%, so instead of $45,000, you’re taking out maybe $49,500 the next year.  And you just simply do the same each year, just like Social Security.  You give yourself a cost of living increase each year with inflation.

Jim:   Alright, and that is calculated in that four-and-a-half percent rate, so you might actually end up taking more than four-and-a-half percent because it’s four-and-a-half percent of the base year.

Bill:   That’s correct.  If your portfolio is growing slowly, as it probably has recently, you can actually see your withdrawal rate increase over time.  Normally, there are fluctuations during retirement.  It can go anywhere.  It can go down or it can go up.  If you’re really unlucky and you retired in, let’s say, 1966, which was a terrible time to retire because you had this huge market decline and high inflation, you know, it’s possible that your money would’ve lasted exactly thirty years and ran out on your dying breath and you would’ve been taking out very high percentages toward the end of your life.  But yeah, the percentage will fluctuate from year to year.  That’s why I say don’t worry about the percentage after the first year. 

Jim:   Alright, so, in effect, it’s whatever you took out the first year plus inflation?

Bill:   That’s right.  It’s a simple rule.

Jim:   Alright, well, that is pretty simple, but I’m kind of a conservative guy, particularly when it comes to clients running out of money, so let’s take two examples.  One, a guy comes to you in early 2008.  He has $1,000,000 and you say, “Okay, take out four-and-a-half percent,” so he takes out $45,000 and, let’s say, using your pattern, continues that taking out $45,000 plus inflation.  Alright, now, six months later, and let’s just say it’s roughly half bonds and half stocks, the stock portion of his portfolio goes down by, say, 40%.  So, now his whole portfolio is down 20%.  Are you going to go back and readjust every year, or are you going to say, “Hey, that was already built in with our initial value of four-and-a-half percent?”

Bill:   You know, that’s a judgment call, and I think it depends upon how, in my opinion and my practice, I look at how the client views that.  If the client is nervous about the situation, I would recommend that they cut back their withdrawals even if the rules say we’re okay, because no one really knows what’s going to happen in the future.  In the past, markets have made big declines and they’ve been followed by very big recoveries, so that people were able to keep that four-and-a-half percent through, because eventually, their portfolios will regain value.  But no one knows for sure what’s going to happen in the future.  So, if a client really feels uncomfortable, there’s no reason they have to feel trapped in a box.  You just reduce withdrawals temporarily or permanently to bring them to their comfort level so they can sleep at night.

Jim:   Well, I guess my question is, are we safe just taking the number that we spent last year and continuing on that for inflation, or is it really safe to say, “Hey, I’m going to reevaluate each year,” and if it is, let’s say, better to reevaluate each year, could we possibly come up to a conclusion that it’s more than four-and-a-half percent because, if we are reevaluating, then perhaps we don’t have the danger of spending too much?

Bill:   You could reevaluate every year.  I think you’re probably better off doing it over a longer time frame, maybe three to five years, otherwise you could get whipsawed by market fluctuations, you know?  But I think it does make sense to look at your withdrawal plan every so often, and maybe make a big correction like you’re suggesting and saying, “Well, you know, we’re doing extremely well with our investments.  Let’s take more out than we had intended, because it looks like we’re going to be okay.”  Or conversely, say “The portfolio’s doing terribly.  Let’s cut back.”

Jim:   Alright, well, by the way, I’m finding this very helpful, and for whatever it’s worth, when I do financial reviews with clients, probably one of the most important things I do is I look to see how much I think they can safely spend.  Interestingly enough, you actually have a chart in your book talking about different spending withdrawal rates based on different life expectancy rates, and I happen to be using that exact same source, so I thought that that was kind of interesting that independently, we came to what we thought was the right source, unless, and by the way, the people that I used didn’t give you credit, unless you’re the one who came up with it and I’m just following what somebody said that you said.  But anyway, a lot of people say, “Well, that’s great if you have a thirty-year life expectancy,” but these days, you have a lot of people who are a little bit nervous, or maybe they just like to work.  I was with a physician today and he just loves working, and I have a lot of college professors as clients, and a lot of those guys keep working well into their seventies and sometimes eighties, and I have a lot of engineers who, if conditions allow, they like going to work, and they work longer, so rather than retiring at sixty or even sixty-five when using maybe a thirty-year life expectancy would be reasonable, they’re retiring at maybe seventy-five or eighty and let’s say, in that case, if you’re going to restrict an eighty-year old, and let’s assume that they’re married and their spouse is the same age, if you’re going to restrict an eighty-year old to a four-and-a-half percent withdrawal rate, you’re really, I think, potentially restricting what they could safely spend.  So, what you have done is you have calculated different withdrawal rates for different life expectancies, and I wonder if you could tell our listeners a little bit about how that works, why you did that and if those results have been vindicated over time?


3. Different Withdrawal Rates For Different Life Expectancies

Bill:   Yeah, that’s an excellent point you make.  Persons who have shorter life expectancies can be more aggressive in their withdrawals because it’s less likely that a major stock market downturn is going to affect them.  If they’re looking to withdraw over thirty years, they’ve gotta be very careful.  But if it’s only ten or fifteen years, well, my table indicates that a person with a fifteen-year life expectancy could go over 6%.

Jim:   And by the way, for whatever it’s worth, I have your book in front of me, and you actually have 6.3% with a total equity allocation of 30%.

Bill:   That’s right.  You want to get more conservative as you age or have a shorter expectancy.

Jim:   And then for a ten-year life expectancy, and by the way, for listeners, there’s sometimes some great times to take notes, and this is one of them, because I’m actually going to go through from ten to thirty years, because I think that this is such valuable information.  For ten years, and the way you call it is peak safe max, with a total equity allocation of 40%, you say people can spend up to 8.9% of their portfolio.

Bill:   That’s right.

Jim:   Alright, and that still hasn’t changed.  Is that correct?

Bill:   Yeah, that’s as valid as four-and-a-half percent is for the thirty-year.

Jim:   Okay.  Then for fifteen years, you come up with 6.3% with a 30% allocation.  For a twenty-year period, you come up with 5.2% with a 30% allocation in stocks, with a twenty-five year life expectancy, you’re at 4.7% with a 45% allocation in stocks, and for thirty years, you’re actually at 4.4% which is pretty close to what you said before, which is 4.5%, and you say a 50% allocation.  So, I think that that is very helpful and I use that table, if not every day, pretty close to it, and I think it’s just so important because we have a lot of older clients and they have, I don’t know whether you’d call it a depression-era mentality or their unwillingness to spend a lot of money, they are concerned about running out of money and many times, they are spending well less than their safe withdrawal rates, and one of the things that I do is I try to show them that they might be able to spend a little bit more money, not that they necessarily do, but using that safe withdrawal rate.  So, I think that that is very, very valuable.

Bill:   Great.

Nicole:   We’re going to take a quick break right now.  We are here with Bill Bengen, and he is the author of “Conserving Client Portfolios During Retirement.”  We’re talking about safe withdrawal rates, and as a quick reminder, we are live, so if you have a question or a comment for Bill or Jim, please give us a call at 412-333-9385.  You’re listening to The Lange Money Hour, Where Smart Money Talks.

Nicole:   Welcome back to The Lange Money Hour.  This is Nicole DeMartino, and this evening I’m here, of course, with Jim Lange, and our guest tonight calling in from California is Bill Bengen.  He is the author of “Conserving Client Portfolios During Retirement,” and we’re talking safe withdrawal rates.  Before we get back to it, I do see that we have a question, though, all the way from Washington State on the west coast.

Jim:   Alright, and by the way, I will remind our listeners that I think that this year, we’ve had more questions from out-of-state than instate, and that is because KQV streams and we have listeners all over the country and they listen on the internet.  By the way, even if you’re local, sometimes the signal is a tiny bit muffled, and sometimes more than a tiny bit, and you might be better off listening at KQV.com.  But, anyway, why don’t we take the caller from Washington?

Nicole:   Carl?

Carl: Yes?

Nicole:   Are you there?

Carl:  Yes, I am.

Nicole:   Alright.  What’s your question for Jim and Bill?


4. Caller Q&A

Carl:  Well, I’m enjoying the show, and I wonder if Bill can please comment on the effect of mutual fund and advisor fees on a state withdrawal rate?  And I’ll take my answer off the air.

Bill:   As far as mutual funds go, in my research, I assume that the investor was using index funds which have extremely low fees, so that the mutual fund fees didn’t enter in to my calculation withdrawal rates they weren’t affected by.  As far as advisor fees, that should be built into the client’s budget for retirement as an expense and should not be forgotten because I don’t think the advisor wants to go unpaid, necessarily.  They’re giving sound advice.  So, definitely, you want to make sure the client has included those fees in their budget and as part of that four-and-a-half percent withdrawal. 

Jim:   Alright, and for whatever it’s worth, some of the money managers that I work with, and I guess I’m going to have to be careful about what I say, but I would say that it would be their hope that their performance would cover the fees.  In other words, their hope would be that their performance would be four-and-a-half percent at or better, or the market or better, after their fee.

Bill:   That’s right, and you have to remember that the four-and-a-half percent is how much you’re withdrawing.  People also have other sources of income during retirement: Social Security, pension plans, and so forth, you know, which can be used to pay expenses.  So, you have to look at the broader picture, as well. 


5. Safe Withdrawal Rates from Taxable Accounts, i.e. IRAs

Jim:   Alright, well, let’s get into the nitty-gritty a little bit, Bill, because you cover this.  And by the way, I’m so glad to have you on because, and I don’t want to mention the names of certain books because I don’t want to say anything bad about anybody, but I will just tell you that there’s a whole bunch of books out there on the safe withdrawal rate and they have not done the research that Bill has done.  They don’t have the depth of insight, and they didn’t have the education, and frankly, the quantitative skills that Bill brings to the table.  So, let’s use some of those quantitative skills, Bill.  Let’s distinguish between an all-IRA portfolio, and I have a lot of clients who have mainly IRAs, for example, college professors, engineers, mid-level managers, people who had, let’s say, they started out their career thirty or forty years ago, maybe they were married and they and their spouse were pretty much broke at the time, and they bought a house on credit, so they had a house payment, and they had kids, and then they had braces expenses and then they had college expenses, and then they had the car payments and everything else, and it was very hard for them to accumulate a lot of money, but they were pretty prudent souls, and they put money into their retirement plan, and the university or their company or Westinghouse or wherever they worked also put in a portion.  So now, let’s say, that they are at or near retirement, and maybe they have $1,000,000 or $2,000,000 or a little less or a little bit more, but virtually all of that money is in an IRA or a 401(k) or a 403(b).  What is important about that money is that they have not yet paid tax on it.  So, how would you advise somebody that, instead of having a million dollars of what I would call after-tax dollars, money that they have already paid tax on, how would you change the advice if they had the $1,000,000 in the IRA?

Bill:   Okay, fair question.  Actually, my research, that four-and-a-half percent figure, is intended to apply to tax-deferred accounts like IRAs.  If you’re examining a taxable account, the withdrawal would actually be about 10% less than that.

Jim:   Wait, wait, alright, well, hang on a second.  Let’s make sure that we understand this.  So, let’s again use $1,000,000 because it’s a nice easy number.  Alright?  So, somebody can take out $45,000, but if the source of the money was all IRA, that $45,000 is going to be taxable.  And let’s say, for discussion’s sake, that to keep it simple, the tax on that is, say, $10,000.  So, they have $35,000 left.  Can they spend $35,000 or can they spend $45,000 and take out more and pay taxes on that?

Bill:   The total that would be available to withdraw during that year would be $45,000, and they must not forget the fact that they have to pay taxes.  The taxes should be considered as a budgeted expense just like advisor fees.  So, they’re netting out $35,000 they’ll have left for discretionary expenses that year.

Jim:   Right, right, and by the way, that’s the way I do it, too.  I tell people, “Okay, you know, if we’re going to use 4%,” or a higher percentage if they’re older, “that’s fine, but you’re going to have to pay taxes for that money.” 

Bill:   Correct.

Jim:   Alright, now what if that money was outside the IRA?  Couldn’t you just say, “Well, then there aren’t any taxes” so they could spend the whole $45,000, or why did you say that you can take out 10% less?

Bill:   The reason is that the taxable portfolio is soon to be paying taxes on all of its investment gains over time.  So, it’s going to grow at a slower rate than the IRA account.  So, if you have a taxable account, you had capital gains, you sold something, or else you had dividends, and you paid income taxes on those as you went.  Therefore, the taxable account is smaller, but because, let’s say, you take out 4% instead of four-and-a-half roughly, than you can only take out $40,000.  But then, that money you can spend freely without any further taxes, because taxes have already been paid over the years on that.

Jim:   Alright, so your rule of thumb then is take whatever number you had before, which was, let’s say, four-and-a-half percent or the higher numbers when we were talking about a reduced life expectancy, and then subtract 10% of that, and then you can spend that money.  Is that right?

Bill:   If you were withdrawing from a taxable account, that’s right.

Jim:   Right, alright.  By the way, it’s great when you get a tough question, by the way, and instead of getting mumbo-jumbo, you get a great answer.  You don’t often get that with a lot of…well, I’d better watch myself here.  Alrighty, now let’s assume, for discussion’s sake, that somebody has a pension plan, and let’s just say, for discussion’s sake, it’s $5,000 a month, alright?  But what is unique about it, well, it’s not so unique anymore, actually it’s kind of standard, is the amount of the pension is fixed.  In other words, it’s not going to be like our legislators that get a nice raise every time there’s inflation or every time they have a bill, but rather than it is, let’s say, $60,000 a year and maybe it’s $60,000 today and maybe, if they live thirty years, it’s still $60,000, but if inflation is at 3%, maybe that $60,000 is only worth $15,000, alright?  So we have, let’s call it, an ever-decreasing purchasing power from their pension.  And by the way, I would say the same thing with Social Security.  Theoretically, Social Security may have some cost-of-living increase.  How would you then recommend somebody handle the safe withdrawal issue in that case?  And by the way, if you can get this one, that’s really good, because I don’t know the answer.


6. Safe Withdrawal Rates on Fixed Retirement Accounts

Bill:   Yeah, that’s a question I’ve explored in great detail.  It’s a very important point because many people find themselves in that situation where they have a fixed pension and they’ve got a sum of money in addition that they’re withdrawing from.  And the answer is that the four-and-a-half percent rate almost certainly is going to have to be decreased substantially, and you have to go through the calculations using software to do it.  The reason is that each year you can take out from your portfolio and give yourself a cost-of-living adjustment, but you’re not going to get that out of your pension plan.  So, if your overall spending is going to go up with inflation, your portfolio now has to do double duty.  It has to give itself a cost-of-living increase, and also the money being withdrawn from your pension plan needs a cost-of-living increase.  So, as a result, I’ve done calculations for clients where, instead of four-and-a-half percent the first year, they had to take out three-and-a-half, or 3%, or even 2.8% so that their money would last, and that’s all because the greatest enemy during a retirement is inflation.  They have to make provisions for that.  A pension plan is kind of like an anchor during retirement because it doesn’t do anything with respect to inflation.

Jim:  Oh Bill, you’re killing me.  I thought you were going to give me an easy answer because I’ve always said, “Well, I’ve kind of included a fudge factor, if you will, and lowered it.”  Alright, so now, you’re telling me that my instinct is right.  The idea of using a fudge factor is accurate.  And now, you’re telling me what I sometimes tell people when I, you know, I go around the country doing Roth IRA conversion workshops, and to determine the optimal amount of a Roth IRA conversion, you actually have to run the numbers and the projections, and we have a combination of Roth IRA conversion software and, by the way, also 1040 software which we think is intricate to the calculation, and then we interpolate and work back and forth, and the truth is there is no easy, quick answer.  So, you said you have to use the software, and I know we have a lot of financial advisors.  Is there a particular program that you can recommend, because I would love to know how to do that?

Bill:   Sure.  There are several excellent financial planning software packages on the market.  I happen to use Money Guide Pro because it’s web-based, so I can share it with my clients.  When I prepare a plan for them, they can see the plan on their own home computer.

Jim:   Alright.  Is that available free for our listeners?

Bill:   Unfortunately, no.  You have to pay an annual fee for that, and it’s pretty significant, you know.

Jim:   Okay, and out of curiosity, because I know we have a lot of financial advisors listening, how much is that a year?

Bill:   I think I’m paying in the range of $1,100 a year for that.

Jim:   Alright, well, that doesn’t sound too bad for me.  I assume it does other things too, but I will tell you that that to me is a really tough issue, and the other thing that I don’t know how to do, and I don’t know if there’s any software in the world that can tell us this, is how to do that calculation if somebody doesn’t have a pension, but if somebody has Social Security.  In other words, can we count on a cost-of-living raise for Social Security?  I don’t think we can, but I don’t have any excellent substantive reasoning or sources that would say that. 

Bill:   In other words, if you have doubts about the future cost-of-living adjustments from Social Security?

Jim:   Right.

Bill:   That depends upon your interpretation of what’s going to happen.

Jim:   Alright, that has to be a true fudge factor.  Alright, now what about this?  By the way, I love when there’s quantitative people who can answer questions, because a lot of times, I have engineers and other quantitative types, and they come in and they ask all the questions that they’re not used to getting an answer for, and then, when they get an answer, they’re pretty surprised.  So I like this, and you’re doing great.  You really are.  I appreciate this, Bill.  Alright, so what do you do now if you have a one-life pension?  So you have somebody who is married, and for some reason or another, they either didn’t do a two-life pension, which is what I typically recommend, or in some variations, although not the ones I’ve found, by the way.  I find that it is usually cheaper to take a two-life pension.  If you do a one-life pension, then you do a life insurance policy to cover the surviving spouse in the event that the person who took the pension dies, so that’s why my starting assumption is two-life.  But, a lot of times, people come to me after that decision has been made, so they might come to me with a one-life pension and no life insurance.  How would you cover that possibility?

Bill:   That’s something where you’re going to have to go to the software again, and run the numbers.  There’s no simple answer to that.  It depends upon how long they expect to live, and I think you want to look at different contingencies.  If they die off sooner than they expected, they may want to be more conservative with their withdrawals to account for that, you know?  That’s a complex issue. 

Jim:   Yeah, because see, this is what happens in real life.  I’d love to say, “Okay, you have a million dollars.  You tell me your mom lived to be eighty.  You’re feeling pretty healthy.”  By the way, what I always do, I don’t know what you do, is I always add some years to what my clients tell me.  It’s kind of an interesting thing.  I say, “Well, how long do you think you’re going to live?”  There’s a couple of jokes, and then they start telling me about, “Well, my mom died when she was 82 and my dad died when he was 77, but he used to smoke cigarettes, so he died of heart failure that now could easily be corrected,” or something like that.  But, what I would typically do is that whatever they tell me, I typically add a few years because I think that the idea here is to be conservative and not to be aggressive, because I don’t want to say, “Oops, I guess we miscalculated.  I’m really sorry that you’re 87 years old and you don’t have any money.” 

Bill:   Yeah, I really endorse what you’re saying there.  You know, when I run those Money Guide Pro projections for my clients the first time, I take them out to age 105, and I usually get giggles from people, because they can’t envision themselves living to 105, but I’ve been in practice for over twenty years, and I had four clients with me who were in their seventies when we started, and they’re in their mid-nineties, in good health and good mind, and they could easily live until 105 and they’re very glad that we took the planning out that far.  So, I think it’s good to have a margin of error in these matters.

Nicole:   Alright, we’re going to take one last break.  You’re listening to The Lange Money Hour, Where Smart Money Talks.

Nicole:   Welcome back to the Lange Money Hour.  We are here and we have about twelve minutes left in the show.  Jim, I think you were writing some things down and you have a couple more questions for Bill.

Jim:   Oh yeah.  I could go on for hours.

Nicole:   Bill, aren’t you glad that this is just an hour?

Bill:   I’m enjoying this enormously.

Nicole:   Good!

Jim:   Well, thanks.  You’re giving us some great information, and frankly, I’m throwing out some of the toughest questions that I come across.  There’s another factor that I want to know if you take into account in your practice, which I do in mine.  Let’s assume, for discussion’s sake, that your analysis is exactly right.  You know, the market goes down at the worst time, you calculated it out, the client lives exactly as long as you’d thought, and he spends his last dollar and dies, so you got it perfect.  But now, they have a $500,000 house.  Let’s say the client said, “Hey, I love my kids, and, you know, whatever I can do to help my kids out when I’m gone, that’s great, and if I make a Roth IRA conversion, as long as it’s not costing me purchasing power, if my kids can be a couple of hundred thousand dollars better off, that’s great.  But, I died with an extra $500,000 that I never spent.  It seems to me that maybe I could’ve gotten a reverse mortgage on it.  Maybe, at some point, I could’ve sold it.”  So, going into that thirty-year period, let’s assume that you have a paid-up house, and let’s just use $500,000 because it’s a nice, easy number, can you take into account the equity of your home in determining how much money you can spend?

Bill:   Theoretically, I guess you could.  I haven’t explored that.  It depends upon the willingness of the client to consider that concept.  Some people don’t want to touch the equity in their home.  Others want to be more aggressive with it.  I think it’s a matter of the client’s preference in that regard.

Jim:   Well, I would say that most clients would prefer not to, but I’ll quote Jonathan Clements on this, formerly of the Wall Street Journal.  He’s no longer there.  But he and I did a column on this issue, and what he said, Bill, is that you could take 60% in the equity of your home and consider that as part of the base of the safe withdrawal rate on the theory that if it ever came down to it, you could either mortgage your home, get a reverse mortgage, and I like the concept of a reverse mortgage, I might not like the fees, but I like the concept of it where you, in effect, spend some of the equity in your home, or for that matter, if it really came down to it, you could sell it.  So, Jonathan says you can’t take 100% because the value of the home could go down, or you might have to pay some fees, etc.  I would say that a lot of clients might not feel comfortable with it.  The way I do it is I present it and then I let the client decide themselves.  On the other hand, I’ll give you an example of one case where it worked out really well.  I had a client, and they had most of their money in their IRA, and they basically needed the full safe withdrawal rate from their IRA, and they happened to be Orthodox Jews, and their most important thing for them during their lifetime was that their grandchildren be educated at the Yeshiva, and even though the tuition wasn’t terribly expensive, there was tuition, and what their plan for that was, was to cash in more of their IRA, pay the income taxes on it, and get the net of that and use that to pay for their grandchildren’s tuition.  And I hated the ideas that they were prematurely taxing their IRA and taking out more than they really should, so we actually ended up doing, you know, I’m kind of a cheapskate, so rather than doing a traditional reverse mortgage, and that might be a very good solution for a lot of people, but what we ended up doing is we basically did a series of home equity borrowings to pay that tuition.  Now, yes, they will likely and almost inevitably die in debt, but what will happen is, in their case, it was a condominium, which will most likely be sold after they’re gone, and then the proceeds can pay off the mortgage and anything left over can go to their children or grandchildren.  But in the meantime, they had that additional money that they could use, now, they happened to choose to spend it to pay for tuition to Yeshiva.  Other people will obviously have different uses for the money.  But I don’t know if you consider that a legitimate way of doing things or not.

Bill:   I think that’s an intriguing and clever idea.  In southern California, of course, we have no home equity left.  No one in southern California, and I’m just kidding, but there are a tremendous number of foreclosures here.  I think, as a concept, that’s worth looking at.  I mean, you have that value.  I think, what I do in my practice is I tell my clients, “Look, we made these assumptions, a lot of assumptions, okay?  In case we’re wrong, you live a lot longer or the market’s a lot worse, you have your home there as a last resort” and we do some of the things you’ve been talking about.  So we kind of keep the home in reserve, but I don’t see why you can’t do exclusive calculations with it like you’re suggesting.  I think that’s an interesting idea.

Jim:   Yeah, I mean, the way I use it is I guess it’s a little bit of a reserve, but also sometimes not being afraid of doing it.  And by the way, on that particular issue, Jonathan Clements and I came to the conclusion that doing a running and ever-increasing home equity loan made more sense than doing a reverse mortgage.  Now, obviously, a lot of the mortgage brokers are screaming bloody murder right now, and I’m sure that in many cases, a traditional reverse mortgage would work.  My problem, by the way, with a traditional mortgage, so let’s say somebody says, “Okay, my house is worth $500,000.”  Let’s assume that the bank would give them a traditional mortgage of $300,000.  My issue then is they don’t need the $300,000 today, and then if they invest it, hoping to do well, to me that’s kind of like an arbitrage situation where you borrow, admittedly at today’s low rates or as low as I’ve ever seen them, you borrow the money and you hope to do better in your investments.  To me, that’s a little bit too risky.  I don’t know if you have any thoughts on that one.

Bill:   Yeah, I would concur with your take on that. 


7. Three Stages of Retirement

Jim:   Alright.  Now, let’s get into, this is an area where your book and I have given different advice, and so we’ll get to this.  Now, this is what I hear a lot: so let’s say that people retire.  They’re 65 years old and they are, let’s assume, both in good health and they say, “Hey, you know something?  I look at my parents, and my parents, you know, after they reached their mid-eighties or ever earlier, they had a real hard time getting around.  Dad got sick, and mom had to spend a lot of time taking care of him, and even if they wanted to spend more money, they really couldn’t because they were just too old to travel.  I’m feeling pretty good right now.  I’m healthy.  Europe beckons.  I want to go to the islands.  I want to have some fun while I’m still healthy and I can still do that.  Can I take out a little bit more?”  And again, that was one of those fudge factors that I never knew exactly how to quantify, but that seemed a little bit okay to me, and then I read your book and you say, “No, no, no, you can’t do that!”  So, why don’t you kill some of the vacation dreams of some of our listeners (laughter) and talk about whether you think it’s legitimate to have a fudge factor for taking out a little bit more early, or whether that is not a responsible thing to do.

Bill:  I’m going to have to read my book again.  I didn’t know I said no.

Jim:   Well, you didn’t say no, but specifically what you said was there were basically three stages of retirement: the unhealthy phase, the last phase, which is older, maybe a nursing home or personal care, etc., and then the one in between, and then you quoted a classic study and then you kind of amended it, but I believe you came to the conclusion that because sometimes you had to consider long-term care or additional expenses in the last stage, you couldn’t really live it up in the first of those three stages. 

Bill:   I think you have to be really careful about what you do in the early years of retirement, because they set the pattern for the latter stages of retirement, and if you consume too much capital early in retirement, you may have to live as a pauper later on, particularly if the market turns down on you.  The early years of retirement, the compounding, as you know, the early years of any investment cycle are the most important, because that money will compound for the longest.  So, if you take that early money and use it early, you may have to cut back a lot more than you expected.  In other words, you might have to go from five-and-a-half percent to three-and-a-half percent in ten years or something really drastic, and you have to decide whether you can actually make that kind of a lifestyle change, and some people can and that’s fine.

Jim:   I’ll bet all the travel agents and hotels are wincing right now.  They don’t want to hear this.  But I think as your point, that you said in your book that it was your experience that a lot of your older clients weren’t able to have higher expenses.  By the way, you have about thirty seconds to answer, so if you could do that, I would appreciate it.

Bill:   Okay.  Yeah, generally, you’d be surprised at how some people think expenses drop later in retirement because of lack of travel.  That’s not true.  You have increased medical expenses, living expenses, perhaps you’re moving into a retirement community, maybe you want to be gifting to your children, though it should be considered an expense.  Don’t assume that your expenses later in life are going to drop off a cliff.  They’ll be much higher than you think.

Nicole:   Alright, Bill.  We’re going to close the show now.  Thank you so much.  Jim’s smiling here, so I know he’s had a good time this evening.  We hope you did too.  Thank you for listening to The Lange Money Hour, Where Smart Money Talks.          

  

  

James Lange, CPA/Attorney

Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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