As an investor, your specific goal is to live off your investments by designing an income stream you won't outlive. As an advisor, the goal is to ensure that you as a client can withdraw assets in perpetuity – because who knows how long you will live?
But what keeps many seniors up at night is the almost-universal fear of running out of money once the last paycheck has been deposited and it's too late to course-correct.
In reality, you have little or no control over two factors determining how long your assets will last: (1) how markets and the economy will behave at any given time, and (2) how long you will live. The response to market behavior falls under the domain of monitoring and rebalancing with your advisor.
But how long you will live is part of growing concern as the average life expectancy of seniors continues to increase, but also, as a sizeable percentage of people risk living many more years than the average. It is called longevity risk.
However, you have control over two other factors: (1) when you choose to retire – the moment you transition from the accumulation phase to the spending phase – and (2) the rate at which you withdraw funds from your accounts.
What is the best rate of withdrawal?
A popular rule of thumb in financial planning is that someone can safely withdraw 4% of their portfolio each year as income from their investments. This is based on the assumption that a conservatively positioned portfolio can earn 4% per year on average.
Financial planner William Bengen promoted this withdrawal rate rule in 1994. The thought was that by withdrawing a specific percentage of the balance of retirement assets each year – and by correcting the remainder for inflation and any change in financial resources – you could count on not depleting your portfolio for at least 30 years. Benson used portfolios of 50% stocks and 50% fixed-income securities in his calculations over rolling 30-year retirement periods starting in 1926.
Over time, people have argued that the mix should be 60% stocks and 40% bonds. Or that the withdrawal percentage should be higher or lower. In any case, retirement calculations will require some guardrails to ensure the nest egg will last as long as the investor.
Today there is more customization involved in retirement planning than just asset allocation. To deal with longevity risk, advisors seek out and explore instruments and withdrawal strategies – or decumulation of retirement savings.
How Savvly can affect the rate of withdrawal
Savvly has developed an investment approach to help retirees cover their expenses and maintain a retirement lifestyle, regardless of lifespan. It is a risk-pooled retirement plan with a recognized stock market index fund as its underlying investment.
Risk pooling allows the common financial risk to be shared among many people. Investors can purchase shares with 5-10% of their retirement assets and select a payout date sometime after their mid-70s.
At that time, they receive their original investment, their capital gain, and their share of the pool's value. Should they die before their payout date, their beneficiaries will receive part of their investment's value, with the balance staying in the pool to enhance the payout of those who do reach their payout date.
In short, with Savvly, investors have certainty about a large lump-sum replenishment – which means that they can withdraw more from their current portfolio for current lifestyle spending. This occurs because the decumulation is offset by the potentially significant payout at their selected payout age.
By shortening the number of years your assets at retirement may have to cover as well as providing higher certainty that the rate of withdrawal does not need to last indefinitely, the percentage you can withdraw each year can increase – for example, to 6% instead of the traditional 4%. Clients should consult with their adviser and determine their safe withdrawal rate.