Question of the Day – Retirement Planning

June 28, 2007

Here’s a question for everyone:

Is it a good idea to spend down principal during retirement?

I realize that most of my readers probably aren’t retired so this topic may seem a little silly to talk about. However, I ask this question because Jonathan Clements mentioned it in his column yesterday (the same column I talked about in my last post). There’s something about spending down principal that just doesn’t sit well with me. It seems risky. After you’re retired, once your principal is gone, it’s gone.

Of course the other side to the equation is that some people may not want to leave a lot of money behind and feel it is their right to spend it. I can understand that. My main concern is running out of money, not necessarily leaving lots of money behind.

Personally, I think the ONLY way I would recommend spending down principal is through a fixed immediate annuity. This type of annuity can even be structured to offer lifetime income no matter how long you live. More on this at a later time. Meanwhile,…

What do you guys think about this?

UPDATE – Reading through the comments and rereading my post, I figured out that I didn’t write clearly. There are low-expense fixed immediate annuities. Vanguard sells them. You’ll have to buy them yourself, but they do sell them and they are quite reasonable. Anyway, as I said, I’ll do a follow-up on this sometime in the future.

10 responses to Question of the Day – Retirement Planning

  1. I’m not sure the immediate annuity would necessarily be the “best” (i.e. most cost effective) way of structuring a principal payout, but it does do the trick and transfers the risk from the consumer to the insurance company.

    I’ve found that eating away at principal is a normal part of many retired people’s financial plans. They simply don’t have enough principal (or low enough expenses) to only spend principal and income. At my firm, we mitigate the risk by overstating the life expectancy. For example, if we’re trying to distribute $200,000 to a 65 year-old retiree, we might do it over a 30-year span. This makes the budget more conservative and often leaves a lump sum for inheritance as well.

    Rather than an annuity, setting up a low-cost brokerage account with fixed income products can be about 1% cheaper.

  2. I agree with much of what Russell stated. Ultimately it should depend on each persons own goals. Many people, usually due to poor planning don’t even have a choice. And, you don’t have to target spending your last dollar on your death bed. The prudent thing to do is to plan for a safety cushion amount. I think the myth of “Never invade principal!” is perpetuated, in part, by the brokerage industry in order to preserve assets and accounts and, therefore, revenues. There is no reason you can’t plan to spend some or most of your principal if you want. It’s your money. You earned it. Enjoy it.

  3. Just recently found your site — very interesting. Actually you do have at least one “retired” reader, me. An immediate annuity may work well, but in my opinion, they are more for people not managing their own money for whatever reason. I prefer the submitted idea above (Bailyn and Dylan) of moving money into brokerage instruments that will provide a dividends and interest focus. The set a percentage to pull out annually, and then actually withdraw it into a reservoir (checking account) quarterly for use. My target is not to die broke, nor to leave my principal untouched, but somewhere in the middle.

  4. Again, this is way too personal of a matter to generalize. It really depends on how the client feels about it, desire to leave inheritance to heirs, health condition, family longevity genes, desired lifestyle, other sources of income (pensions, Social Security), etc. Lots of financial planners try to impose their own prescriptions without LISTENING and fully understanding the client and what he/she/they want out of life (and their money).

    How do I personally feel about this question?
    I like to bring out the “rule of thumb” of spending 4% of your portfolio in retirement. I think 4.4% is still a prudent amount to shoot for, assuming it helps achieve what the clients want. There is recent research indicating an even higher withdrawal rate…but, again it comes down the individuals! It’s perfectly fine to build a nice cushion and I think it’s perfectly fine to spend some of that cushion when the client is in the 60s and 70s instead of building that cushion up even more so they can spend it when they can not walk or walk with a cane or a scooter:-)
    As years go by, life throws out some curve balls at you and you help the clients adjust. For example, a client has been diagnosed with terminal cancer and he is only 62 and he has decided to go out with a bang (after of course fully ensuring the wife will be taken care of). Will he spend some principal now?…You Bet!

  5. As Russell quotes Siegel just before the part about spending down your principal “you won’t live forever”.

    Life is about taking risks. No, not the unnecessary ones, but some you can’t avoid. The loss of purchasing power of an immediate annuity due to inflation is a big risk (more like a certainty) Planning to spend your money over 30 years starting at age 65 is somewhat less of a risk. On the average, you have less than a 5% chance of outliving your money. At even a 3% inflation rate, what will the purchasing power be at the end of 30 years? Less than 1/2 of what it was in the beginning.

    On the other hand, if you can save up enough to live off the dividends of a stock portfolio, then as long as the dividends are increased to cover inflation, you would not need to touch your principal. But again, you’re not going to live forever. Do you see it as your responsibility to provide for your children’s retirement?

  6. I agree with EMF when he says “if you can save up enough to live off the dividends of a stock portfolio, then as long as the dividends are increased to cover inflation, you would not need to touch your principal.”

    That I guess is the best way, but then again, it’s up to the retiree on how he wants to spend his money. All that matters is he/she should know how to handle money wisely. Earning your retirement money is a lot of hardwork while losing it is as easy as 1 2 3.

    off topic: I would like to know, how can I be added in your ‘links Page’? I think we share common niche and that my articles can also be of help to your readers.

  7. I’m not sure exactly what an immediate annuity is, but here in the UK almost everyone purchases an annuity by the time they reach 75. Its very difficult to do anything else with your tax-advantaged retirement accounts as the government doesn’t want you to spend all your own money and end up being subsidised by them.

  8. There are better ways to pass on wealth to your heirs than through your retirement nest egg and brokerage accounts. I can understand why someone may not want to touch the principal so they have something to pass on, but ultimately I’d rather be able to provide tax-free money to my survivors.

    Sure, it would be great to never have to tap into the principal and just live off of the income your investments produce but for many people that isn’t a reality, and even if it is it may not be appropriate.

    The way I see it is that my retirement savings are meant for me, and if to accomplish the things I want to in my later years requires tapping into principal then so be it. If I happen to have an untimely death and there is money leftover for my survivors that is just a bonus. But the bulk of the wealth I pass on probably won’t come from my brokerage accounts unless I happen to die quite young.

  9. insanity to go annuity route. without more than a mention of the high fees and commissions, quite simply, an annuity means you are giving your principal away never to be seen again. the only way to play the annuity game is to be on the side issuing the annuity to the poor ill advised customer. o.k. did i offend all you annuity sellers? good.

  10. OK I need some advice, you know the free kind. I’m 59 years old and have been diagnosed with cancer the doctor said it is in remission but probably come back in two years. I own my home and have about $750.000 cash and 275000 in equities. My present home is worth 200.000. I have 500,000 in life insurance. My pension starts at 60 at 45,600 anually. My wife has 50% survival. We both want a new house at 535,000. Am I being foolish to even consider this?