By Dr. Jim Dahle, WCI Founder
I heard an interesting statistic at the Bogleheads Conference last year. Here it is:
“Only 1 out of 7 retirees spends any of their principal.”
Wild, right? Everyone is worried about running out of money in retirement. The truth is that few retirees are running out of the money they saved up for so many years. Granted, lots of people never had any, and they are living on Social Security combined with the goodwill of friends, family, and neighbors. Don't believe me? Check out these charts from Vanguard's How America Saves Study.
That's right, the median 401(k) balance is about $33,000. That's less than two years of the maximum contribution. Even among the 55 and older crowd, the median is only around $80,000. What kind of income does an $80,000 401(k) provide you? That's $267 per month. Basically, it'll pay for Netflix, your cell phone bill, and one tank of gas. Hope Social Security covers the rent, groceries, and healthcare.
Why don't people have any money in their 401(k)s? It seems pretty obvious once you look at this chart:
That's right, nobody is saving anything. Only about half of those making > $150,000 are maxing out their 401(k)s. When you include everyone, only 12% are maxing out their 401(k)s. So, when I'm talking about those who are actually saving something significant for retirement, we're only talking about a small percentage of investors. (If you maxed out your 401(k) this year, give yourself a pat on the back.) But of those who actually save something for retirement, almost nobody runs out.
Not Running Out of Money During Retirement
There are a few reasons for this:
#1 Adjustments
Nobody withdraws blindly. They adjust as they go. When hard times come for their investments, they spend less.
#2 Huge Portfolios
Tons of retirees have “oversaved” with regard to their actual need to spend. They are perfectly comfortable and content to spend less than they could be safely spending. Katie and I wouldn't be anywhere close to a 4% withdrawal rate if we quit working right now, and we're still working and probably will be for a while. Lots of people don't quit just as soon as they have “enough.”
#3 Caution
People are cautious about how much they withdraw from portfolios. Historically, if you blindly withdrew 4% per year from your portfolio (adjusted upward with inflation each year) for 30 years, you would, on average, have 2.7X the amount you retired with still in your portfolio. Only in a small percentage of historical scenarios do you (after 30 years) have less than you retired with, much less run out of money.
#4 Death
People plan for a long life, but most of them don't get it. I refer once again to the classic chart titled “Rich, Broke, or Dead” from engaging-data.com.
At 90, 80% of people are dead, and less than 5% are out of money. Of those still alive at 90, far more of them are rich than broke. For you to run out of money, two “bad” things have to happen: crummy returns AND a long life. If either of them doesn't happen, you don't run out of money.
#5 Never Spending Principal
Finally, this is what I want to talk about today. I think a lot of people have an illogical fear of spending principal. I don't know who said it first, but “Never Spend Your Principal” has been spouted as investment wisdom for many years. It's totally wrong, of course.
It does have four very nice benefits, however.
- You will never pay capital gains taxes (although mutual funds could pass some gains through).
- It will be extremely easy to see how much you can spend.
- You will never run out of money.
- You will be sure to leave a very nice inheritance (can I be your heir?).
Despite the benefits, it's the wrong thing to do. You ABSOLUTELY CAN spend (some of) your principal for two reasons.
- You are constantly making more principal as you go throughout your retirement, and
- You are not going to live forever.
Typical growth (i.e. risky) investments, such as stocks and real estate, gain in value over time. Yes, some of the return is paid out as income, but there is additional return that is not paid out, often even more than the rate of inflation.
More information here:
Some Sobering (and Scary) Statistics on People’s Retirement Preparedness
Income Investing Is Behaviorally Smart?
However, the statistic that only 1 out of 7 investors spend principal in retirement is still staring us in the face. There is something powerful there. Even if it is not MATHEMATICALLY optimal to not spend principal, perhaps it is BEHAVIORALLY optimal to just spend the income. Many investors have a very hard time switching from being accumulators to being decumulators. After a lifetime of saving, saving, saving, it's psychologically tough to actually spend that money. In fact, doing so requires you to admit two difficult things to yourself. First, you are no longer earning enough income to cover your (appropriately) desired level of spending, and second, you will not live forever. Neither is psychologically easy. But that income rolling off the investments . . . that feels an awful lot like that paycheck you used to have. That is easy to spend.
As much as the purist in me hates to tell a retiree to have a portfolio more focused on income so they FEEL better about spending an appropriate amount of it each year, the truth is that personal finance is both personal (80%) and finance (20%). It's often a good idea to do the “wrong” thing (focus on income) if it leads to the “right” outcome (spending an appropriate amount of your portfolio). Plus, the tax aspects don't matter as much if you're actually spending the money (although they should still be taken into consideration). Still, don't go hog wild and build a portfolio of junk bonds, extreme value stocks, and annuities just to boost yields. But if you want to pay off your real estate mortgages to increase the income from the properties, allocate some money toward something like a real estate debt fund, put a little more in bonds, or add a value/dividend tilt to the stock portfolio, I think that's all fine.
More information here:
Spend Those RMDs
Another financial advisor at the conference said almost all of his elderly clients simply reinvest their Required Minimum Distributions (RMDs). That is, they take the money out of their traditional IRA, pay the taxes due on it, and reinvest it in their taxable account. I wasn't surprised. My parents mostly do the same thing. We tease each other a lot about finance and politics. My dad complains an awful lot about poor market performance for someone who doesn't even spend his RMDs.
Maybe if I publicly shame them here, they'll start spending them—even if this might not be the best year to do it!
As far as portfolio withdrawal strategies go, just spending your RMD is far from the worst. Yes, RMDs can get pretty big as you move into your 80s and 90s. But your life expectancy is also getting pretty small in those decades, and as a percentage-based method, you'll technically never run out of money spending your RMDs.
Setting a Spending Minimum
For those of you having trouble spending as much as you can during retirement, here's another idea. Set an amount that you have to spend each year. Put a penalty on it. Maybe if you don't spend it, it has to go to the national committee for the political party you don't support, for instance. Or perhaps, better yet, it goes to your favorite charity. Maybe that will help you to spend some principal.
More information here:
Doing Some Simple Math
Still struggling to spend principal? Think about it this way. The long-term return on the stock market is 10% a year. Maybe we can't expect that in the future. Fine. Let's make it 8%. Or even 7%. Now, the yield on the market is about 2%. That still leaves you a 5% increase per year on average. While inflation is high right now, it averages around 3% in the long run. So, you can easily spend 2% of principal in addition to that 2% income and still expect your money to grow at the rate of inflation. This is going to work out just fine.
If you need extra help with planning for retirement or have
questions about the best way to save your money in tax-protected accounts, hire a WCI-vetted professional to help you figure it out.
Did I convince you? Are you willing to spend a reasonable amount of principal in retirement? Why or why not? Comment below!
It’s behaviorally smart to spend your RMDs in retirement, as it’s difficult to switch from being an accumulator to a decumulator. While it’s important to consider tax implications, don’t be afraid to adjust your portfolio to focus more on income to make spending easier.
Great post! But just to clarify, the statistic is that only 1 in 7 retirees spend down principal, correct? That’s what it says in the beginning, but it also says the opposite later in the post.
Yes. Thanks for the correction.
Great article. Everything makes sense from an analytical/data standpoint. But as you point out, personal finance is extremely personal and often motivated by fear.
How are you spending down principal (or making plans to) and what do you do overcome the fears, however irrational in the face of facts, data, etc.?
Heck, I’m worse than not spending principal, I’m adding to it each month! Some retiree I am.
Great post, just want to add your spending can include charitable and if you have a traditional IRA you get the benefits of QCDs to factor in to your RMDs. Not wishing my life away but am very much looking forward to my 70- and one-half birthday.
73???
RMDs begin at 73 under Secure Act 2.0 but QCDs still begin at 70.5
This is spot on! My 84 year old day has had RMDs since 70 1/2. Never spent any RMDs, complains about his quarterly taxes. But get this, his 401k account balance is larger today then when he was 70 1/2! He also is an old school CD investor, where cash is now king. Again proud to say he has never spend his principal. Down side to all this is CD income pushing him into higher tax brackets and IRMAA surcharge which now and in future 2 year look back will claw back on his future SS payments. I said Dad , you’ll really have something to complain about on your future quarterly tax payments and SS.
Andrew, congrats to your Dad, income that generates income tax is the nicest of problems. My earlier post referred to the qualified charitable distribution as credited 100 percent (or $1 for $1) against the RMD applicable to a traditional IRA, which within the $100k limits means the QCD is transferred tax free to the charity, isn’t income to the IRA owner and doesn’t count toward MAGI for IRMAA purposes. This works very well for my Mom’s IRA and her church pledge, more that it frees her defined benefit income for living expenses than tax benefit or managing IRMAA cliffs. However, I don’t think those benefits are applicable to a 401k so you might want to check with your tax person and consider rolling it over to an IRA.
I always find these stats interesting. They don’t seem to take into account people having old accounts rolled over into IRAs. I’m sure there are plenty of people with multiple 401k/IRAs that aren’t much individually, but add up to a nice amount together.
I’ve always thought this too! I have 401ks from 3 different jobs still chugging along separately across 3 different providers, if for example Fidelity did an analysis of my savings they’d be like “holy cow this guy has very little for retirement!” but I have plenty across the other two accounts.
QCDs are very helpful for those not spending their RMDs.
PS I’m going out on a limb and guess that even if if the 401(k) was up 30%, your dad wasn’t voting for Biden anyway.
Who knows with my dad, but I think my mom votes a pretty straight ticket.
I’ve always thought this too! I have 401ks from 3 different jobs still chugging along separately across 3 different providers, if for example Fidelity did an analysis of my savings they’d be like “holy cow this guy has very little for retirement!” but I have plenty across the other two accounts.
I never adopted “spending as much money as I can” as a goal in life. Same with “doing as little work as possible.”
I suspect that many of the retirees who never touch their principal (or at least do not touch their after tax RMDs), spend as much as needed to live the lives they want. Someone who is living the life they want may feel no pressure to spend more money on things they would rather not have.
The problems with spending after tax RMDs as a strategy are that it ties spending to the moves of the market and it ignores money outside of retirement accounts.
The market will bounce around year by year but most of us want a smoother spending pattern than that. We want to sustain our spending in a down year and have no interest in increasing spending just because the market had an up year.
Many people have assets that are not subject to RMDs. Taxable accounts or Roths, for example. For many, the after tax dividend income from stocks in a taxable account and the after tax income from SS and/or pensions more than covers their needs. They are required to take RMDs but they have no need to spend the money. So they save it.
Someone who lives largely or entirely on RMDs, with no taxable or Roth savings, might budget the after tax RMD amount very differently from someone for whom the tax deferred accounts represent a relatively small share of their assets. It is highly unlikely that both individuals will optimally have the same strategy around RMDs.
If they are living under a bridge and eating scraps with $10M in a 401k, then yes, they should loosen up and pay for a decent life.
If they already have a decent life without spending after tax RMDs, then I do not see a problem
Once you reach eudaimonia, there is no urge to go buy something else.
Your comment “I never adopted “spending as much money as I can” as a goal in life.”
Let’s assume both you and I have just enough money to cover all our needs, and a decent amount of our wants in perpetuity. We are effectively financially independent and ready to retire. Tomorrow, Ed McMahon creates a trust on our behalves that will give each of us an extra $1k a month (inflation adjusted) for the rest of our lives.
I don’t know about you, but I can relatively easily find a good place to spend that extra money. May it be my favorite charity, a $12k vacation once a year with the family of the god parents of my kids, maybe it means leasing the latest car every year, maybe it means paying someone to help take care of an elderly parent, or maybe it means flying first class more often,. Or something else you may find desirable. My point is, maybe Jeff Bezos doesn’t have anything else to spend their money on, for the rest of us mortals I think there is always room to spend in a way that can improve our lives or the lives of those around us. Eudaemonia is relative.
I’m not saying spend money frivously just cause you have it, as I agree, that is a waste. But there are plenty of things in my mind that can have real value for us. For those of us who saved their entire lives and lived below our means. It can be really difficult to spend that extra $1k a month even if one easily can.
sigh………
I think the author touches on this briefly, but after 50 years of being
frugal, pay as you go human, it is more painful to convince yourself to spend.
versus the joy in spending will bring…..
while not exactly the same, I could increase my alcohol intake now that I have no job responsibilities,
but I have made “habits” and comfort level in terms of drinking….
same can be said of spending……….
no right or wrong here…..but just trying to give you insight on others point of view
“while not exactly the same, I could increase my alcohol intake now that I have no job responsibilities,”
When I retire, I anticipate “increasing” my drinking from zero to zero.
Not that cost is the reason, but alcohol is expensive and not drinking is free.
“Let’s assume both you and I have just enough money to cover all our needs, and a decent amount of our wants in perpetuity. We are effectively financially independent and ready to retire. Tomorrow, Ed McMahon creates a trust on our behalves that will give each of us an extra $1k a month (inflation adjusted) for the rest of our lives.”
Right. We are on different pages.
Assuming this extra $1,000 per month is a gift and not taxable, it would all go to savings. When I say there are not other things I want to buy, but hold off because of cost, I mean it.
My inflation-adjusted spending is lower now than it was 20 years ago, although income and assets have increased by a large amounts. In fact, part of the reason assets have increased is because income has gone up and spending has gone down.
There really are not other things I want to buy. I don’t want to eat at fancy restaurants. I do not need any more clothes and if something needs to be replaced, they are cheap. I don’t need a new car and would not replace my 11 year old car if I had another $1,000,000. If I don’t want a new car, it does not matter what the cost of a new car might be. I don’t want to fly somewhere for an exotic vacation. That is, I would rather stay home than take such a vacation even if the trip were free. Having more money will not make me spend one penny more on vacations. I do not accumulate art, jewelry or collectibles.
I have what I want and I am not looking to spend more money.
If I had a lot more money I would probably increase my contributions to charity. But since my plans include charitable gifts at death (of the second to die), charities will benefit from any extra money we have. Having more money would not change my monthly expense.
Basically, I do not believe that spending more money would make me happier. There is not something I want that I could only afford with more money. At least, there is no such thing that I know about. And I am not looking for things to buy for the sake of buying things.
In summary, if I had an extra $1,000,000 a month in income, there is nothing extra I would buy. I could convert it to cash and set it on fire if I were determined not to save it. But that would be a waste and it would generate greenhouse gases.
I, just last week, sold a rental property (a principal) and I am not too happy about it, but there was no other way to manage my expenses. So I was not wanting to spend my principal, but I had too. You too may not be thrilled to spend down your principal.
Sorry you had to do that.
It’s nice to have it to spend though isn’t it? One nice thing about paying cash when you buy nice cars or boats or whatever is that even thought they’re depreciating, if you really had to you could get some cash out of them by selling them.
My traditional IRA is quite modest, and I spend the required minimum distributions on paying the income tax on my Social Security
I have some sympathy for those who do not save enough for retirement. Not everyone is a doc with ample income to support themselves and save for the future. Many people struggle to get by and should be congratulated for setting anything aside. The median salary is $50,000. For 40 year old individuals it is $55,000. Pretty hard to save a lot of money with those incomes. Nine % of adults have less than a high school diploma. Only 15% have advanced degrees.
We are in a very fortunate income and educational class. When we only talk with each other, we lose sight of the circumstances of most people in this country.
Here on WCI, we are used to hearing of docs with high 6 figure incomes who lack the willpower to control their spending. They have a very different problem.