Do You Know Your Safe Withdrawal Rate?

On this episode of The Long View, Mark Berg, founder of and lead advisor at Timothy Financial Counsel, discusses hourly financial planning, retirement, and client behavior.

Here are a few excerpts from Berg’s conversation with Morningstar’s Christine Benz and Jeff Ptak.

How to Find Your Safe Withdrawal Rate

Christine Benz: Sticking with retirement planning and people who are on the cusp of retirement, one perennially hot topic in that area is safe withdrawal rates, how much someone can safely withdraw from their portfolio per year through retirement. How does your firm approach that question, helping people set their sustainable withdrawal rates?

Mark Berg: That’s a great question. There’s so many things that come into play with that decision. What level of fixed income they have coming in from, say, Social Security or a pension or a combination, obviously their lifestyle, their portfolio mix, taxable versus tax-deferred or tax-free. But I would say that more often than not with the type of person that’s attracted to hourly [financial planning], we are finding that we’re typically more encouraging spending than discouraging spending. Meaning, they’re living so within their means that their withdrawal rate is 1% or 2% or 3%. And especially, as they’re aging into their 70s and 80s, their spending levels, actually, their draw rate typically is actually leveling out, if not declining. So, we feel that 3% to 4%-ish percent range in the younger end of retirement with some exceptions and then, it creeps up over time, has worked well. I think that originally the [William] Bengen studies and some supported it. Then it seemed to fall off, and now it’s back. But that 4% to 5% range seems to be sustainable. Obviously, with the inflation question right now, we’ll see how that all plays out. But we do a lot of income-replacement planning for our clients as they near retirement and then all through retirement and making sure, in a tax-efficient manner, we can meet all of their lifestyle needs.

The ‘Retirement Spending Smile’

Jeff Ptak: We also wanted to ask you what you’ve observed when it comes to retiree spending patterns. Our former colleague David Blanchett has popularized the notion of the retirement spending smile. His point being that spending isn’t this straight line, that it varies over the course of retirement. What have you observed in practice in working with retirees?

Berg: I have observed the same. I think I, again early in my career, took that lineal approach and that compounding expense approach too seriously. What I have seen is, from retirement until, let’s say, mid- to upper 70s, right around there, that is the sweet spot where they still have, for the most part, they have their health, and this affords them the ability to travel and to do things that they maybe didn’t do as much or even at all that they could do in that first phase of retirement. I have found myself, especially over the last 10 years, really encouraging clients to enjoy. We obviously do it within planning and make sure that we’re staying within a level that’s sustainable.

One couple always comes to mind with this topic where they were the truest definition, they were the living definition of depression-era mentality. They had passive income streams from pensions and Social Security that covered all of their expenses. So, they had this pretty good-sized portfolio that was basically one large emergency fund, and they had no dependents. So, there wasn’t even somebody that they could or were interested in passing along to. It took me probably three years to convince them it’s OK, you can spend. And I ended up being actually pretty forceful in my recommendations, especially one of the spouses was so fearful. They took their first trip, came back, they were different people. And it has been a joy each year as we set a budget for enjoying a lifetime of earning. Now their health is getting to a point where they can’t travel, hardly at all anymore, and they’re right in that time frame that I had mentioned. And that’s when you see a transition.

That next phase, people think, well, medical expenses are going to get more. Well, Medicare actually handles a lot of that, and their expenses pretty much flattened out. They’re basically the same number year over year. Now there might be a change in categories. Maybe more in medical-related, out-of-pocket or whatnot, but less in a lot of the other categories and especially the discretionary categories—eating out, travel, clothing, and so on. We see that flatten it out. And then, typically, you may see a change if they’re needing some care of some sort. So, that will obviously change the equation. But we’ve definitely seen that expenses do vary by circumstance. And that’s why when people have the impression that retirement planning, once you get into retirement, it’s basically on autopilot. We would wholeheartedly disagree from experience, meaning as we’re meeting with clients on a very regular basis and seeing how their life is being managed on a year-to-year basis, it requires staying on top of things, because the circumstance can change on a dime. So, I would agree with the research that’s being done, that it is not just this lineal perspective. It’s a very dynamic issue that needs to be managed.

Long-Term-Care Risks

Benz: You touched briefly on long-term care, how some clients encounter a long-term-care need later in life. And this could be a whole podcast unto itself. But how do you address long-term-care risks for clients who are younger like in their 50s? What’s your preferred prescription on that front?

Berg: I would say just like any risk management, you are looking to share the risk of a potential outcome with an insurer, whether it’s life insurance, long-term care, disability, and so on. And long-term-care need is still an if not a when, but more and more we’re seeing people are living longer and not being able to do those activities of daily living. So, we typically start by stress-testing the plan. What we’ll do is look up current statistics on duration and costs to their specific area and see is it affordable? But then, we’ll talk about what are their goals? Because they may say, well, I really want to make sure that I leave a certain amount of legacy, and a prolonged long-term care could affect that. So, that comes into play.

The cost of long-term care is not insignificant. That’s the other side, is looking at can they afford what long-term care costs? In the past, we used to be able to control that with a 1 pay or a 5 pay or a 10 pay, and that locks in the cost and the benefit. The insurance companies for a variety of reasons have moved away largely from those products and you’re just dealing with not only the annual cost increase, but sometimes pretty dramatic increases in cost over time or a change in benefit where you have to give up a cost-of-living adjustment or decrease the coverage.

So, most often with our clients, I would say, we look at long-term care for those that it does make sense to purchase as not a replacement, but just another stream. So, we’ll look at, OK, you’re already bringing in Social Security, you’re already spending X amount through your RMDs and through withdrawals in your portfolio, and what we’re trying to ensure is the above and beyond, the unexpected and the duration. Instead of maybe buying a $350-a-day with cost-of-living increase, which can be for, let’s say, unlimited benefit, which is going to be a very sizable premium, we may look at $100 a day and maybe instead of unlimited, maybe it’s a five-year or a higher, call it, deductible, meaning that there’s a longer period before you start receiving the benefit to help manage the cost and fit it within the structure of their overall financial plan. So, it’s definitely one of the topics that needs to be discussed.

Then there’s the client’s own persuasions as it relates to insurance. Some people avoid insurance at all costs. Other people are very, very comfortable and see it as a great tool to manage risks or fears or concerns that they have. So, as we’ve been saying all along, financial planning is not one size fits all. You really have to customize it to that client and their specific circumstance and their mentality. That’s the approach that we take with our clients.