Americans aren’t terrific at saving for retirement. Many are even worse when it comes to figuring out how much to spend once they get there.
An actuary who’s studied the issue for three decades recently proposed a relatively straightforward strategy that can help. In its simplest form, the “Spend Safely in Retirement” plan suggests waiting until age 70 to claim Social Security and using the IRS’ required minimum distribution table to determine how much to withdraw from savings each year.
Even those who stop work earlier can use the strategy, or a version of it, to figure out when they can afford to retire and how much they can spend, says Steve Vernon, a research scholar at the nonprofit Stanford Center on Longevity in Stanford, California. Vernon worked with the Society of Actuaries to study nearly 300 different retirement income approaches. The strategy was the best way for middle-income people with $100,000 to $1 million saved to create an income stream, Vernon says.
Most people nearing retirement don’t consult a financial adviser, and only about half try to calculate how much money they’ll need to retire comfortably, according to surveys by the Employee Benefit Research Institute. Instead, retirees typically take one of two approaches, Vernon says:
• They try to minimize withdrawals, viewing their retirement savings as an emergency fund that must be conserved, or
• They wing it, using retirement savings as a checking account to pay their current living expenses without much thought for the future.
“These approaches really aren’t ideal,” says Vernon, author of several books on retirement. The winging-it crowd often burns through their money too fast, while the conservers may spend too little.
Traditionally, financial planners have recommend the “4 percent rule” — withdrawing 4 percent of retirement savings in the first year and increasing the amount each year by the rate of inflation. Recently some researchers have questioned that approach, saying it may not be safe enough for retirees who could be facing a lower-return environment than previous generations.
Another way to set up a retirement income is to buy an immediate annuity, which offers a stream of payments in exchange for lump sum, from an insurance company. Many retirees, however, don’t want to give up a chunk of money that they won’t be able to access in an emergency or leave to heirs.
Social Security, on the other hand, is a kind of annuity that can be a solid foundation for most people’s retirements, Vernon says. Benefits increase with inflation, don’t fluctuate with the market and can’t be outlived.
If people can delay claiming benefits until they are 70, they’ll get the largest possible check. (For married couples, only the higher earner needs to wait until 70, Vernon says. The other spouse can begin Social Security checks at full retirement age, which is currently 66.)
Once maximized, Social Security benefits likely will make up 75 percent or more of the typical retiree’s income, Vernon says. With the bulk of their income guaranteed, retirees can keep their savings invested in stocks to reap inflation-beating growth. A balanced index fund or a target-date fund can be an easy, low-cost way for them to invest, he says.
Those who want to quit work earlier, say at age 65, can use some of their savings as a “transition fund” to replace Social Security checks.
“There’s some judgment involved in the size of the transition fund,” Vernon says, since carving out too much could leave too little to live on later. People may need to reduce their living expenses and consider working part-time.
Withdrawals can start at age 65, using an initial 3.5 percent withdrawal rate. At age 70, people can switch to the IRS’ required minimum distribution table, which dictates how much people must take from most retirement accounts at that age. The withdrawal rate at 70 is 3.65 percent and it increases slightly every year after that; by age 90, for example, it’s 8.7 percent.
The spend safely strategy won’t make up for inadequate savings, and some people may need to supplement their income by tapping their home equity, either through a reverse mortgage or by selling their house, Vernon says.
How much people withdraw can vary considerably every year with the rising and falling of the stock market. But the method allows people to squeeze as much income as possible from the savings they have without running out, he says.
“We really didn’t set out to find a simple solution,” Vernon says. “But compared to the others, this is the best.”