How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 6

Parts 1-5 of this series highlighted the challenge in determining a definitive retirement number. Nevertheless, against my better judgment, today you will receive some simplistic retirement nest egg calculations; since we all like to know what everyone else thinks their number should be. Who the heck knows, if any of these numbers will be in the ballpark or not.

Before I get to the numbers, you will read about some Canadian income tax idiosyncrasies and the impact income taxes and inflation have on your anticipated retirement withdrawal amount.

Made In Canada Idiosyncrasies

One significant issue for retired Canadians is that your annual minimum Registered Retirement Income Fund (“RRIF”) withdrawal starts at 7.38% and averages approximately 8% of your actual RRIF balance over the first ten years. If your spouse is younger, you can elect to use their age to calculate your minimum RRIF withdrawal amount, which will lower your yearly required withdrawal. In either case, where the majority of your retirement funds are in your RRIF, the required withdrawal may be substantially higher than the 3-4% you plan to withdraw annually from your retirement nest egg (However, as per my example for Mr. and Mrs. Bean below, if you can split pension income with your spouse, the income tax cost of the excess withdrawal may be mitigated).

A discussion of how to manage the drawdown of your RRSP and take into account the minimum RRIF withdrawals is too fact specific and beyond the scope of this series. I may however, post a future blog on this topic.

For higher income Canadians, their Old Age Security may be clawed back as their retirement income increases. For 2014, the clawback starts at $71,592 and your OAS is fully clawed-back at $115,715.

I am The Blunt Bean Counter –So let’s get Tax Centric

As discussed way back in Part 1 of this series, the 4% withdrawal rule ignores income tax. Thus, I will provide you with some examples of how income taxes may impact your selected retirement withdrawal rate. These examples illustrate the tax centric framework I use for one of my own retirement nest egg estimates, which I then compare with other retirement calculators, formulas, etc. proposed by other expert retirement planners.

You will note my model is just a variation on the 4% rule and still ignores investment fees. However, I am going to assume you use low cost ETF’s so that your costs are minimal or if you use an investment advisor, your returns are at least market after accounting for your management fees ( ha ha). I am also going to assume the yearly inflation adjustment under the 4% rule will cover off inflation if not overcompensate for it. Just accept these assumptions for the time being. I know Michael James is flipping with the investment fee assumption.

Sample Data – Mr. and Mrs. Bean

Let’s say Mr. and Mrs. Bean each expect to receive full Old Age Security (approx. $6,500) upon retirement and that Mr. Bean and Mrs. Bean anticipate they will receive $12,000 and $6,000 respectively a year in CPP retirement benefits. Finally, assume Mr. and Mrs. Bean will have equal RRIF’s or make the election to split pension income such that they will each receive $50,000 in RRIF payments in Scenario 1, $40,000 in Scenario 2, $30,000 in Scenario 3, $25,000 in Scenario 4 and $20,000 in Scenario 5.

Using the sample data above, here is the Bean’s income tax situation upon their retirement.

Mr. Bean	Scenario 1	Scenario 2	Scenario 3	Scenario 4	Scenario 5
Old age security	$6,500	$6,500	$6,500	$6,500	$6,500
CPP	$12,000	$12,000	$12,000	$12,000	$12,000
RRIF	$50,000	$40,000	$30,000	$25,000	$20,000
Total income	$68,500	$58,500	$48,500	$43,500	$38,500
Tax payable	$14,400	$11,100	$7,700	$5,800	$4,500
Net after-tax amount	$54,100	$47,400	$40,800	$37,700	$34,000
Mrs. Bean	Scenario 1	Scenario 2	Scenario 3	Scenario 4	Scenario 5
Old age security	$6,500	$6,500	$6,500	$6,500	$6,500
CPP	$6,000	$6,000	$6,000	$6,000	$6,000
RRIF	$50,000	$40,000	$30,000	$25,000	$20,000
Total income	$62,500	$52,500	$42,500	$37,500	$32,500
Tax payable	$12,600	$9,100	$5,600	$4,200	$3,000
Net after-tax amount	$49,900	$43,400	$36,900	$33,300	$29,500
Combined after-tax	$104,000	$90,800	$77,700	$71,000	$63,500

The Tax Effect – Ouch

In Scenario 1, Mr. and Mrs. Bean will pay almost as much in personal income tax ($27,000) as they receive in OAS and CPP ($31,000). Consequently, their true cash available for spending is essentially the gross withdrawal from their RRIF’s, likely a huge cash flow surprise for Mr. and Mrs. Bean. In Scenario 2, taxes eat up approximately 2/3 of Mr. and Mrs. Bean’s pension income. For Scenario’s 3-5, the impact of taxes though still significant, starts to decrease as a percentage of pension income and overall income under each of those scenarios.

Playing with Numbers to get a Tax Centric Number

At this point, let’s play with some of these numbers and see if we can come up with a crude ballpark number for the Bean’s retirement nest egg. As I stated on day 1, this framework is clearly limited, is

based on the 4% withdrawal rule and has no academic basis and should not be relied upon as the sole determinant for your own retirement planning. 

Determine Your Spending Requirements

One of the most important inputs into any retirement calculation is your anticipated spending. Mr. Bean, who is an anal accountant, has used Quicken for years to track his spending and can project which of these expenses he will still have in retirement. The amount he needs to add to his projected spending amount for travel is his “retirement wildcard”, but Mr. Bean is comfortable he can estimate this amount and not be materially wrong. Your spending requirement should really be a yearly calculation and should typically account for higher spending in the early years of your retirement and lower spending in the later years, plus account for one-time expenses like a car purchase, helping pay for a child’s wedding or assisting your child buy a house; however, for this crude calculation, I just use a set spending rate.

Reverse Engineering Mr. Bean’s Retirement Needs

 

[Note: For purposes of this example I am assuming all the Bean's funds come from a RRIF to exaggerate the income tax effect; in reality, you will probably have anywhere from 20-40% of your retirement funds in a non-registered account(s). In addition, I do not try and account for the fact the required RRIF withdrawal may be in excess of 4%].

Once Mr. Bean determines his spending requirements, I can work backwards to help him determine his retirement number under my tax-centric formula. For example, if I assume the Bean’s spending requirement is going to be $71,000 a year in retirement and they have $31,000 in pension benefits, the Bean’s will need to make up a $40,000 retirement shortfall before I factor in income taxes. By co-incidence Scenario 5 reflects that exact situation. The Bean’s will each draw $20,000 from their RRIFs and have a combined income before tax of $71,000 ($38,500 + $32,500).

Of course, Scenario 5 reflects that after tax, they will only have $63,500 to spend, which is $7,500 short of their needs. Thus I need to gross-up the $40,000 withdrawal so the Beans can achieve their required retirement objective of $71,000 a year. Luckily I have a tax program that makes this easy to determine (you can do this with your personal tax program if you do your own taxes or use an online calculator) and when I run the numbers, I determine the Bean’s will need to take $50,000 or $25,000 each from their RRIFs (instead of the $40,000 or $20,000 each I required before tax in Scenario 5) to net out to their required $71,000 a year spending requirement. Again by a strange co-incidence, this is essentially Scenario 4 above.

Mr. Bean is short a few beans.

Since the Bean’s will need approximately $50,000 before inflation for each year of retirement (in addition to their CPP and OAS), I can now utilize the 4% withdrawal rule to estimate the amount of money they will need to retire. The magic number is $1,250,000 ($50,000/.04), which if you believe the 4% rule, will allow the Bean’s to withdraw $50,000 plus inflation for approximately 30 years or $71,000 after-tax including their pension income. If the Bean’s want to provide a measure of safety and use a 3% withdrawal rate, they would require a nest egg of $1,666,666 ($50,000/.03). Mr. Bean however told me to stick with the 4%, since as an accountant; he has led a stressed life and does not anticipate making it past 85 anyways.

The above calculation results in an inflated magic number as it assumes 100% in registered funds. In reality, the number would be based on a draw-down between your registered and non-registered accounts.

When I told Mr. Bean these results, he was thoroughly depressed. However, with my warped sense of humour, I went on to tell him if he was to retire in ten years and he required $50,000 in non-indexed RRIF withdrawals (CPP and OAS are indexed for inflation) he would actually require approximately $61,000 in yearly withdrawals if inflation averaged 2%. That would push him closer to Scenario 2 above. That would mean he would require almost $80,000 in RRIF payments and using a 4% withdrawal rate he would need to have $2,000,000 at retirement, a staggering number. Personally, I think you cannot look at a 2% inflation rate and just inflate your spending expectation. I would suggest wage increases may partially offset these increases and presumably the extra 10 years of investment returns and new deposits would make it possible to get to $2M in 10 years even if they don’t have $1.25M now. In any event, it is a sobering calculation.

Comparing Apples to Oranges to Pineapples

When I started this series, I was foolish enough to think that I could utilize the Bean's income and spending parameters to provide you with comparable nest egg numbers using various retirement expert's formulas. However, as I discussed in Part 5, there are multiple variables and assumptions that affect each calculation which makes an apples to apples comparison impossible. This will be vividly demonstrated as I walk through the various comparisons below.

Yet, I thought it would still be interesting to see how various retirement experts and their formulas, equations etc. compare when given the same retirement spending level and the same pension numbers. It is enlightening, if not slightly amusing, to see how the retirement variables are applied and the significant variances in the final nest egg determination.

What a Financial Planner Says

William Bengen, the man behind the 4% rule, says that “Where the client has any degree of complexity to their retirement situation at all, I find I must have financial planning software to incorporate all these factors….The financial planning software is essential to blending all these elements and coming up with a withdrawal rate and the use of Monte Carlo, and so forth—I just find that essential”.

So I took Mr. Bengen’s advice and had a financial planner run some numbers on his software for me, based on the above $50,000 RRIF requirement and $31,000 of pension income. In the end our comparison was not apples to apples. His software forced him to make various assumptions I could not include in my crude calculation and he wanted to use a 3.5% real rate of return. He also decided he wanted to allocate the non-registered and registered accounts equally amongst other assumptions I could not make with my limited tax centric model. So what did his software reflect as the required nest egg? His number was $1,335,000.

In this Globe and Mail article from last week, the financial planner comes up with a retirement nest egg of $1,240,000 with a couple retiring at 65 and planning to spend $75,000 a year, with a life expectancy of 95 who receive two-thirds the maximum CPP/OAS payments ($25,000 a year) and who achieve an annual return of 5 per cent, in an environment of 2-per-cent inflation.

Jim Otar’s Retirement Asset Multiplier

I next turned to Jim Otar, a financial planner and mechanical engineer (what is with engineers and retirement?). Jim is the author of Unveiling the Retirement Myth. Jim considers there to be three basic risks for retirement financing:

1. Longevity risk
2. Market risk
3  Inflation risk.

He uses an asset multiplier to factor in these risks. Jim does an awesome job of using “plain English” in this article “Do we have enough to retire?”.

You may not believe this, but I had done all my calculations above before I found Jim’s article. Honestly, it is just a fluke he used $70,000 as his required retirement spending (versus my $71k) and $32,000 for his pension income (versus my $31k). When I use Jim’s multiplier of 28 x my $40,000 pre-tax shortfall, I come to required retirement assets of $1,120,000. I am not sure how, or if Jim even factors in income taxes, into his multiplier.

Moshe Milevsky’s Equation

In Chapter 1 of Mr. Milevsky’s book , “The 7 Most Important equations”, he has a chart showing how much money you need for a 30 year retirement based on a real (after inflation) spending amount. Now to be fair to Mr. Milevsky, he says his first equation does not address taxes and you should use his final all-encompassing equation in Chapter 7. However, that chapter is about sustainable spending and I can easily grab a number from his Chapter 1 chart, so I will use the numbers in this chart and take some liberties with my calculations. If I gross my required spending up to $50,000 to account for  taxes as I did in my tax centric model and use a 3% real return rate that Mr. Milevsky says in his book is reasonable in today's economic environment, his equation would reflect a retirement nest egg of  approximately $990,000.
However, I have read where Mr. Milevsky has stated that in general you need 20-30 times your anticipated spending in retirement, so I think $990,000 would be at the low end of what he would suggest, so I will take the liberty of saying he would probably be more comfortable using a number closer to $1,100,000 for comparison purposes.

 

Michael James

I asked Michael to use his calculator that I discussed in Part 3, to determine the Bean’s required nest egg. He assumed an allocation of 15% in bonds, 15% fully safe and 70% in stocks. He also assumed a 4% real return for stocks and a 2% real return for the bonds. He also assumed a very efficient ETF portfolio with fees of only 0.2%:

Michael determined if the Bean’s want to live indefinitely, they will need a nest egg of approximately $1,680,000. If they plan to live to the age of 95, they will need approximately $1,070,000. If they plan to live to 90 they will need around $960,000 or so.

If Michael used a 2% Management Expense Ratio (“MER) instead of his ultra low cost MER of 0.2%, his figures jump to $3,250,000 if you plan to live indefinitely, $1,270,000 for age 95 and $1,090,000 for age 90.

Summary of $71,000 Spending Requirement

If the Bean’s require $71,000 to spend in retirement after-tax (including $31,000 in pension income), the various calculations would suggest that they should be shooting for a nest egg at the low end of $1,100,000 to $1,350,000 at the high end.

As noted above, I have taken liberties with some of the calculations and the variables would change for your specific assumptions and facts. Like I say in my title, who the heck really knows what you need to retire; all these numbers may be consistently wrong, but the above at least provides a starting point of some sort, even if simplistic.

What if the Bean’s have a $104,000 after-tax Spending Requirement?

Since my chart for the Bean's includes a scenario (#1) where they have a requirement for a $104,000 in after-tax spending ($131,000 in pre-tax income), let's see what the various formulas would reflect as their nest egg requirement for that level of spending.

Blunt Bean Counter – $2,500,000 ($100,000 RRIF/.04%=$2,500,000 for a 100% registered account).

Jim Otar –$2,044,000 (as the $104,000 is an after-tax spending amount and Jim uses a pre-tax spending shortfall, I have estimated that spending shortfall to be approximately $73,000)

Financial Planner –$2,250,000 using the same variables as noted in the prior example.

Moshe Milevsky –$1,978,000 at 3% real return, $2,100,000 at 2.5% return (as per his chart in Chapter 1 for a $100,000 after-tax shortfall).

Michael James – if you want to live indefinitely you will need approximately $3,370,000, if you live to age 95 the magic number drops to around $2,150,000 and at 90, it's $1,920,000 and finally, at 85 it's approximately $1,650,000.

If Michael used a 2% MER instead of his ultra low cost MER of 0.2%, his figures jump to $6,510,0000 if you plan to live indefinitely, $2,530,000 for age 95 and $2,190,000 for age 90.)

Summary of $104,000 Spending Requirement

If the Bean’s require $104,000 to spend in retirement after-tax (including $31,000 in pension income), the various calculations would suggest that they should be shooting for a nest egg at the low end off $2,000,000 to $2,500,000 at the high end.

Canadians Know Best

A recent BMO Harris Private Banking survey said that Canadians with investable assets of $1million or more say they need on average $2.3 million to live out their ideal retirement lifestyle. Based on the above, it looks like they are in the ballpark.

Final Caveat

Throughout this series, I’ve shared with you my research and analysis and provided you with as much information as possible so that you can try and determine (or at least consider) the assets you need to accumulate for your own retirement nest egg. There is not one definitive number. Keep in mind, one size does not fit all. My retirement funding includes the sale of my partnership interest; yours may include the sale of a business or a severance payment for taking early retirement. The point being, we all have unique situations.

Conclusion – This Series is Finally Over!!

After going through the analysis I provided to you, I've determined that I am much further away from my retirement goal than I had anticipated and I will still be working for several more years. I now wish I had a company pension. The largest surprise of this exercise to me is that I may give consideration to purchasing an annuity with some portion of my retirement funds, to ensure I have a constant minimum cash flow. Depressing as this exercise was, it brought some clarity to my retirement planning. I also realized that I have no idea whose Monte Carlo simulator will hit the jackpot and that historical data can be interpreted in so many ways it leaves your head spinning.

I do know a multitude of factors beyond my control may impact my expected withdrawal rate (see Part 5 for the laundry list) and thus as a result, I will have to:

1. Be flexible in my spending requirements and may need to be open to working part-time in retirement

2. Review, revise and refine my retirement plan on a consistent basis to account for financial and life events and any changes in my behaviour

In conclusion, I hope my quest or journey for freedom 55,65,75, helps guide your retirement planning. 

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 5

In Parts 1-4 of this series, I reviewed various studies and commentaries to help you determine an appropriate safe withdrawal rate for your retirement nest egg. I also provided alternatives and/or variations to the safe withdrawal guidelines. Today, I examine the factors that can impact both the funding of your nest egg and your withdrawal rate in retirement. The unpredictable nature of most of these factors make it virtually impossible to determine a definitive retirement number and is why I say the "Heck if I Know or Anyone Else Does" how much money you need to retire.

Your Longevity - The Ultimate Wildcard

It goes without saying, that if we knew who long we would live, retirement planning would be a lot simpler. Unfortunately, the best we can do is plan based on longevity studies and family medical history. The Vanguard paper I referenced in Part 3 of this series cites such as study by the Society of Actuaries which found:

“there is an 80% chance that at least one spouse will live to age 85, a 55% chance that one will live to age 90 and 25% chance one spouse will reach 95.”

In Canada, the average male lives to approximately age 79 and the average female lives to approximately 84. Based on the above, your retirement planning should at a minimum assume one spouse will live to at least 95 years old.

Inflation – Grasping for the unknown

The rate of inflation can drastically alter your retirement savings and consumption. An economic environment of low market returns and high inflation can severely impact the funds you accumulate to fund your retirement and the real returns you achieve in retirement. Conversely, interest rates tend to rise with inflation, providing a potential buffer if you lock in higher interest rates and inflation subsides (I remember Canada Savings Bonds paying 19.5% interest in 1981 when inflation was around 12.5%, however, inflation was back down to 4.5% by the end of 1983 and many people were very pleased they had CSB's or GIC's paying very high rates of interest for many years). An average inflation rate of 2% will mean that the $50,000 you expect to spend in retirement in 2014 dollars will require approximately $61,000 in spending in 2024.

One of the criticisms of the 4% rule is that the models cumulative inflation adjustment may force you to take larger and larger withdrawals without regard to your actual spending requirements. Substantive evidence for this criticism is provided below by David Blanchett, the head of retirement research at Morningstar in Chicago.

In this Wall Street Journal article by Kelly Greene, Mr. Blanchett said the following about the correlation between spending and inflation. "Pretty much every paper you read about retirement assumes that spending increases every year by [the rate of] inflation." Ms. Greene went on to say that "when he analyzed government retiree-spending data, he found otherwise: Between the ages of 65 and 90, spending decreased in inflation-adjusted terms. Most models would assume that someone spending $50,000 the first year of retirement would need $51,500 the second year (if the inflation rate were 3%). But Mr. Blanchett found that the increase is closer to 1%, which has big implications over decades, 'because these changes become cumulative over time,' he says".

Sequence of Returns – Bull vs Bear Markets upon your Retirement

The various studies that support a 4% retirement withdrawal, included periods of both bear and bull markets. If you are lucky enough to retire at the beginning of a bull market, your retirement funding will be drastically different than if you retire at the beginning of a bear market. William Bergen in his original 1994 article said:

“This is a powerful warning (particularly appropriate for recent retirees) not to increase their rate of withdrawal just because of a few good years early in retirement. Their “excess returns” early may be needed to balance off weaker returns later.”

It is interesting to note that Mr. Bergen showed that even if you started retirement in the great depression or in the recession of 1973-1974 (which also included a period of high inflation); your money would still have lasted over 30 years, because of the power of stock market recoveries.

However, Moshe Milevsky and Anna Abaimova in this report for MetLife (see page 4 of the report, page 7 of the PDF), very clearly reflect the dramatic difference in retirement outcomes you will have when you have negative market returns early in your retirement vs later in your retirement.

In this blog, Wade Pfau states that:

“In fact, the wealth remaining 10 years after retirement combined with the cumulative inflation during those 10 years can explain 80 percent of the variation in a retiree's maximum sustainable withdrawal rate after 30 years.”

Thus, prudent planning would be to start your retirement following a bear market :).

Registered vs. Non-Registered Accounts

The allocation of your retirement funds between registered (RRSPs, LIRAs, Pensions, etc.) and non-registered accounts (bank, investment, TFSA, etc.) will have a significant impact upon your cash flow in retirement. If you consider all the money in those accounts as capital, the capital in the registered accounts is fully taxable, meaning that if you are a high income tax rate taxpayer, you may be paying as much as 46% or higher upon the withdrawal of those funds. For non-registered accounts, the withdrawal of capital is tax free. This issue raises the much debated question of TFSA vs. RRSP as you accumulate your retirement nest egg and for those who own corporations, the issue of salary vs. dividend (see my three part series "Salary or Dividend? A Taxing Dilemma for Small Corporate Business Owners" from last year on this issue and my 2014 Update). The drawdown of your RRSP/RRIF and/or funds from your holding company in a tax effective manner requires a detailed analysis of your specific situation and cannot be addressed here in a generic manner; however, suffice to say, it is an important cash flow issue. 

Home Sweet Home

Some planners such as David Aston suggest you try and exclude your home from your retirement savings and have it serve as a back-up for any retirement shortfall. However, for many people, part of their retirement will include at least the incremental benefit of downsizing their home. For others, their retirement will only be funded by selling their home and moving into an apartment or reverse mortgaging their home.

Spending in Retirement - Sharpen your Pencil

If you are diligent about this process, you should be able to at least determine a ballpark number for your anticipated spending upon retirement. The spending wildcard for many people is travel. Good health will allow for years of travel, while poor health will not only restrict how much you can travel, but could lead to significant medical costs. In a perfect retirement model you would factor in greater spending as you begin retirement and smaller spending as you grow older. In addition you need to consider occasional and lump sum expenditures.

The aforementioned David Blanchett suggests many peoples spending in retirement maybe overstated by as much as 20% in traditional retirement models. Mr. Blanchett details these views in a very interesting paper on “Estimating the True Cost of Retirement”.

You may also wish to consider your spending in context of the three stages of retirement Michael Stein CFP came up with in his book “The Prosperous Retirement, Guide to the New Reality". In his book Michael suggests there are 3 stages of retirement:

Go-Go Stage- Retirees maintain the same lifestyle and their spending remains fairly constant with their spending pre-retirement, essentially because they still consider themselves “young” and travel extensively.

Slow-Go Stage - Stein says that between the ages of 70-84, your budget will decline 20-30% as your body is not quite able to keep up with your mind and your intended activities or you just become weary of airports and trains.

 No-Go Stage - As you reach 85+, health issues tend to cause you to restrict travel and you are tied to a certain place, be it your home or a retirement home.

Pensions - The Older you are, the more you Appreciate them

If there is one thing this series has revealed to me, is that I truly underestimated the worth of a defined benefit pension plan. I had never really considered the possibility of purchasing an annuity in retirement, however, the more calculations I undertook, the more I realized that without a company pension plan, it may be prudent to consider purchasing at least a small annuity in my retirement. Moshe Milevsky suggest that annuities should be used to “pensionize” part of your retirement funds and that it may be worth the piece of mind to forgo potential growth of your nest egg to provide some comfort that you will not outlive your retirement funds.

If you have a pension plan that covers off most of your retirement spending needs, you are afforded the freedom to take greater equity risk in retirement; since you can withstand stock market swings, knowing your day to day costs are covered off by your pension. Those without a pension face the dilemma of whether to annuitize some portion of their retirement funds or not.

Healthcare coverage - Will we be Fully Covered in 25 Years

As Canadians, we assume we will always have full medical coverage. But who knows if the government will have the money in twenty-five years to support a top-heavy population. In addition, if your health deteriorates and you require private care, all your retirement funds could be eaten up by those costs.

Interest Rates – Will they ever Rise?

People have been expecting interest rates to rise for several years. Many of those same people now think the US government will be forced to keep rates low for the foreseeable future. Selfishly, higher interest rates would be welcomed by many people in or near retirement. A spike in interest rates would likely cause some disgruntled stock market investors to re-allocate their equity investments to fixed income instruments.

Inheritances - No One Plans for an Inheritance do They?

Baby boomers will inherit a massive amount of money in the next twenty or so years. However, the size of individual inheritances will fluctuate widely based on the longevity of their parents. I wrote a blog a while back on whether you should plan for an anticipated inheritance. I suggested that if you are certain you will inherit money, you should at least consider factoring a discounted amount of your potential inheritance into your retirement planning.

Lifestyle in Retirement

For Canadians who live in large cities, have expensive homes and lifestyles, an easy solution to an underfunded retirement is to downsize/sell your home and move to a less expensive city. Whether you are willing to do that is another question.

Evolving into retirement - Keeping the Income Stream Alive

Stan Tepner, CPA, CA, MBA, CFP, TEP, First Vice-President & investment advisor with CIBC Wood Gundy and an advisor to some of my clients, told me "he often finds many people consider retirement an absolute event. One day you are working and the next you’re golfing". He adds "that more and more people 'evolve' into retirement. They may shift into part-time employment or self-employment. This shift may be required for financial reasons or because you wish to keep your mind sharp. Either way, the extra income will assist in funding your retirement needs, especially if you have a savings shortfall because of poor market returns or you have just miscalculated your actual retirement needs".

Next Monday in the final instalment of this series, I will finally provide some numbers on how much you may need to retire.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 4

On Monday, I discussed modern studies that continue to view the 4% withdrawal rule as feasible in today's current environment. Today, I look at various reports and studies by retirement experts who feel the 4% rule of thumb is excessive based on statistical simulations and the inclusion of worldwide market data amongst other reasons. In addition, for those who feel a constant spending strategy is flawed, whether, the withdrawal rate is 2, 3 or 4 percent, I offer some alternative spending approaches.

The Naysayers: Studies that suggest a 2%-3% Withdrawal Rate may be a Good Starting Point

What William Bernstein has to Say

William J. Bernstein is a well-respected financial theorist, who is referenced in many of the articles I’ve read on the safe withdrawal question.

In this Wall Street Journal article by Jonathan Clements, Mr. Bernstein says the following: "Two percent is bullet-proof, 3% is probably safe, 4% is pushing it and, at 5%, you're eating Alpo in your old age...If you take out 5% and you live into your 90s, there's a 50% chance you will run out of
money."

For those who wish to read what Mr. Bernstein has to say, here is Part 1, Part 2 and Part 3 of his series titled “The Retirement Calculator from Hell”. In Part 3 he comments:

“The historically naive investor (or academic) might consider reducing his monthly withdrawals to a very low level to maximize his chances of success. But history teaches us that depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand.”….."But if you believe that we’re about to encounter a bad returns sequence or simply wish to leave a few baubles to your heirs, you’re right back to 3% again.”

What Wade Pfau has to Say

Wade Pfau is a vocal modern day opponent of using a 4% withdrawal rate. Wade is a retirement researcher who has a Ph.D. in economics from Princeton and is currently Professor of Retirement Income at The American College. Wade has a popular blog, called appropriately, Wade Pfau's Retirement Researcher Blog .

In Wade’s 2010 paper “An International Perspective on Safe Withdrawal Rates: The Demise of the 4 Percent Rule?” he makes clear his issue with previous withdrawal studies when he says:

“It is widely acknowledged and understood that the applicability of these withdrawal rate studies depends on the future behaving with the same patterns as the past. But a potential problem with the findings of so many of the existing studies is that they are based on the same Ibbotson Associates’ Stocks, Bonds, Bills, and Inflation (SBBI) monthly data on total returns for U.S. financial markets since 1926, a time interval for which there are fewer than three nonoverlapping 30-year periods. Either these data are used directly for historical simulations or bootstrapping approaches, or used to calculate parameters for Monte Carlo simulations. The problem is that the period covered by this data may have been a particularly fortuitous one for the United States. If one thinks of the world as a Monte Carlo simulation, then the single path observed in the 20th-century United States may not represent its true underlying distribution of returns, and future returns are likely to be lower.”

In this 2013 article in the Journal of Financial Planning, by Wade, Michael Finke and David M. Blanchett titled “The 4 Percent Rule Is Not Safe in a Low-Yield World” it states:

“Pfau (2010) showed, the demonstrated success of the 4 percent rule is partly an anomaly of U.S. market returns during the 20th century. In most other countries, sustainable initial withdrawal rates fell below 4 percent. This study indicates that there is nothing inherently safe about the 4 percent rule. When withdrawing from a portfolio of volatile assets, surprises may happen. This study demonstrates that when financial planners recalibrate assumptions for Monte Carlo simulations to market conditions facing retirees in 2013, the 4 percent rule is anything but safe. This research also shows that a 2.5 percent real withdrawal rate will result in an estimated 30-year failure rate of 10 percent. Few clients will be satisfied spending such a small amount in r­etirement.”

With all due respect to Wade, I certainly hope he is wrong, because you may not have to worry about retirement, as you may not ever be able to save enough to stop working.

The Journal of Financial Planning has a very interesting discussion involving William Bengen, Jonathan Guyton and Wade Pfau in this article titled "Safe Withdrawal Rates: What Do We Really Know?"

What Michael Nairne has to Say

After reading all these academic studies, I started wondering what someone who manages money for clients in the “real world” would say. This led me to ask Michael Nairne, CFP, RFP, CFA, president of Tacita Capital Inc. who writes the Serious Money column for the Financial Post, for an opinion. I solicited Michael’s opinion since we have mutual clients and I have come to appreciate he is not only technically savvy, but a stock market historian. Michael suggested the problem with the 4% rule is "that a singular historic 'backtest' represents just one perspective on withdrawal rates". As illustrated in his article, “The Plight of the Conservative Retiree”, Michael says "the underlying average annual real return experience that funded these assumptions was about 2% for government bonds and 7% for equities. Expected annual real returns going forward are much lower today – about 1% for government bonds and 5% or so for stocks. He feels that for the typical, large cap and bond portfolio, a lower number is better – say 3% or so".

Safe Withdrawal Rates - Tweaks and Variations for Today's World

So whether you are a William Bengen fan and have selected a 4% withdrawal rate or think Wade Pfau has it right and have selected a withdrawal rate of 2.5% -3%, you still may still hear Moshe Milevsky whispering in your ear, that any rule that has a constant withdrawal rate grown by inflation is a horrible rule. Well, don't fret. Colleen M. Jaconetti and Francis M. Kinnry Jr. wrote a 2010 research report titled "A more dynamic approach to spending for investors in retirement". The authors express some of the same concerns as Moshe Milevsky about the 4% rule (constant dollar amount withdrawal adjusted for inflation), most specifically that:

"This strategy is indifferent to the performance of the capital markets, with the result that investors may accumulate unspent surpluses when markets perform well and face spending shortfalls when markets provide poor returns. In either case, the strategy provides short-term spending stability; however, the long-term consequences (positive or negative) can be significant if an investor does not make as-needed adjustments along the way."

The authors note that the common alternative to the 4% rule; basing your spending on a percentage of your portfolios actual value at the end of the prior year can also be problematic in that your withdrawal rates may fluctuate widely in the short-term, while your actual short-term costs are fixed.

Jaconetti and Kinnry attempt to address the limitations of the two above alternatives by introducing a hybrid approach to sustainable spending. They suggest you consider applying a ceiling and a floor to percentage based withdrawals. Under this approach, you:

"calculate each year’s spending by taking a stated percentage of the prior year-end portfolio balance. The investor also calculates a “ceiling” and “floor” by applying chosen percentages to the prior year’s spending amount. The investor then compares the three results. If the newly calculated spending amount exceeds the ceiling, the investor limits spending to the ceiling amount; if the calculated spending is below the floor, the investor increases spending to the floor amount."


You can read the paper for more details, but the authors model portfolio using a constant dollar spending amount ran out of money 2,900 time out of the 10,000 computer simulations, while the model portfolio using the hybrid approach only ran out 1,100 times. In more than half the computer simulations, the percentage of portfolio approach resulted is having less money to spend than the retiree's initial spending target.

Todd Tresidder a financial coach wrote a terrific article titled "Are Safe Withdrawal Rates Really Safe". Unfortunately I did not discover this article until after I had wrote much of this series, but if you are not sick of this topic yet, I strongly suggest your read his article. He says that:

"unfortunately, no simple 'plug and play' model has surfaced to replace the 4% rule (which probably explains why is has persisted despite inaccuracy)."

He then provides a four step process to serve as a guideline for a safe withdrawal rate that includes a "correct and adjust" step. Essentially he is saying stay flexible. You should feel free to adjust a 4% withdrawal rate to 3%, reduce or eliminate the inflation adjustment or alter any part of your withdrawal strategy to protect your retirement fund.

Planning – It is not an Eight Letter Word

Please keep this very poignant excerpt from the Trinity Study in mind when considering your safe withdrawal rate.

“The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning”.

I would suggest that planning should not be limited to your withdrawal rate, but should also be considered in respect of the accumulation of your retirement nest egg.

Believe it or not, you are only two-thirds of the way through the series. In Part 5 you will read about the various factors that impact your retirement and make it virtually impossible to know how much money you really require to retire. Then finally, in Part 6, I provide some numbers to determine how much you need for your retirement nest egg.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 3

Last week in Parts One and Two of this series, you read about the commonly accepted 4% withdrawal rule. This rule of thumb suggests that if you have an equally balanced portfolio of stocks and bonds, you should be able to withdraw 4% of your retirement savings each year adjusted for inflation and those savings should last 30-35 years. Today, I consider an alternative point of view, and then review modern studies and reports on how the 4% withdrawal rule is viewed in the context of market returns over the last decade.

Set Retirement Withdrawal Rates Should Never be Used!

If you agree with Moshe Milevsky’s opinion (see his quote in Part 1) that any rule that starts with a set withdrawal rate, whether 4% or 3%, is a horrible rule, then you should just read to the end of this section and click the exit button (however, please come back for Parts 5 and 6). From what I can gather, Mr. Milevsky and many other retirement experts do not like the 4% rule because it uses a constant spending amount and does not adjust to your evolving level of wealth. By shunning a set withdrawal rate, retirees may avoid spending shortfalls where their investments underperform and will not accumulate surpluses when they outperform the market. My interpretation is that Mr. Milevsky feels you should spread your economic resources over your entire life and that your spending rate and retirement withdrawal number should not be fixed to an arbitrary level, but that your spending rate should depend upon your personal preferences and your views on longevity risks.

Mr. Milevsky may be critical of a set withdrawal rate, but he does not just point out the flaws and walk away. In his book The 7 Most Important Equations for your Retirement he provides a unique set of mathematical equations to determine your retirement needs.

These equations allow you to determine amongst other retirement issues, how long your nest egg will last, what is your suitable spending amount, and in his final chapter he helps you determine if your current plan is sustainable.

I found this book innovative and as entertaining as a math book could be (Moshe uses seven historically famous people to introduce his equations). However, to be honest, I had challenges with the math, especially the final equation in Chapter 7. You may want the math wiz in the family to assist you with your calculations. I would suggest at minimum, you use Moshe’s equations to back-test whatever retirement nest egg and spending rates you arrive at.

Michael James

Before I move onto the modern safe withdrawal rate studies, I have to give a shout out to Michael James, a fellow Canadian personal finance blogger who created his own strategy, which includes holding five years of savings in a savings investment account. His "Magic Number" calculator is here. The background to his calculator is discussed in his blog post titled "A Retirement Income Strategy" and in this second post on the topic.

Modern Studies and Reports

The Bengen and Trinity studies, from which the 4% withdrawal rule originated, utilized stock market data from 1926 to 1976 and 1926 to 1995 respectively. Many commentators feel this historical data is no longer applicable in today’s world.

To help you determine if 4% is a safe withdrawal rate for you (with the limitations I noted in my first post), I’ve summarized below several current studies and reports on this topic. Some of the studies/reports continue to condone the 4% withdrawal rate or are at least accepting of using a 4% withdrawal rate as a starting point. Others feel it is excessive and if you withdraw 4%, you will be eating cat food at some point in your retirement.

If you are like me, you will probably be overwhelmed by these reports, their arguments and their data. Although you will never achieve certainty, your withdrawal percentage is the vital wildcard in trying to estimate your retirement nest egg and, you must draw a line in the sand using a percentage within your comfort zone, assuming you believe in a constant withdrawal rate strategy or a variation of the strategy.

The Studies that suggest a 4% withdrawal is still a Good Starting Point.

 

What Charles Schwab has to Say

In this report by Rob Williams, Director of Income Planning for Schwab Center for Financial Research says that Schwab suggests “the 4% rule as a starting point for planning purposes. Then, it's important to stay flexible as you spend in retirement”.

However, the report goes on to say that “Based on Schwab's current expectations for market returns over the next 30 years, we calculate a 3% spending rate to begin retirement may be more appropriate—if you want to follow a rigid rule for spending, and have a high degree of confidence that your money will last.”

What Vanguard has to Say

In this excellent report, one of several Vanguard has written over the years, the report states:

“For the majority of years from 1926 through 2011, the yield or income returns on a 50% stock/ 50% bond portfolio exceeded 4%. Over the last several decades, however, the yield for such a balanced portfolio has

been steadily decreasing. At its peak, in 1982, the portfolio’s average yield was 10.6%; by year-end 2011, the yield had dropped to 2.8%.” Yet, Vanguard says that a 4% withdrawal rate is still a reasonable starting point.

The report goes on to say:

“Specifically, Vanguard’s market and economic outlook indicates that the average annualized returns on a balanced 50% equity/50% bond portfolio for the decade ending 2021 are expected to center in the 3.0%–4.5% real-return range (Davis and Aliaga-Díaz, 2012). Although this level is moderately below the actual average real return of 5.0% for the same portfolio since 1926, it potentially offers support for the continued feasibility of a 4% inflation-adjusted withdrawal program as a starting point for balanced investors.”

Vanguard also has an excellent report on alternative spending strategies for those who are concerned that the constant 4% plus inflation adjusted amount in the rule of thumb may result in excessive withdrawals in poor performing markets. I discuss that report tomorrow.

What David Aston has to Say

David Aston, a certified management accountant and contributing editor to MoneySense magazine, wrote an article for the September/October 2012 issued titled “Make your nest egg last”. In that article he says that if you want to stick with the 4% rule, there are four strategies to limit the risk. They are as follows:

1. Cut withdrawals if you suffer losses. “Bengen encourages retirees to keep an eye on their ‘current withdrawal rate,’ which is the annual drawdown as a percentage of a portfolio’s value today (as opposed to its initial value at the time of retirement). As a guideline he suggests cutting back if you exceed the following current withdrawal rates: 5.6% at age 65; 5.9% at age 70; 6.25% at age 75; and 7.5% at age 80.”

2. Use your home equity for backup

David feels you should exclude the value of your home from your initial retirement nest egg. You can always tap the equity as back-up in case your investment returns are not what you expect. I suggest this could be at least partially problematic for many retirees who plan to downsize to fund their retirement.

 3. Add annuities to the mix. David states that many experts suggest that age 70 is the sweet spot for purchasing an annuity. He notes that most annuities will pay nothing to your estate; they expire upon your death or the last spouse to die if you own a joint annuity. Many of the articles I read suggest that you consider annuities as a component part of your retirement. Moshe Milevsky in his book Pensionize Your Nest Egg is very keen on using annuities and other products to ensure you do not outlive your money, where you do not have a substantial pension in retirement.

4. Invest conservatively—This is self-explanatory.

On Wednesday, I will review comments made and studies undertaken by retirement experts that feel the 4% withdrawal rate is excessive.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 2

On Monday I introduced the 4% rule, the most commonly accepted rule of thumb retirement strategy. Today I discuss the guideline and its development in greater detail. As noted in part 1, Moshe Milevsky and other retirement experts feel the rule is misleading and a terrible rule. I hope by the time you finish reading this series you will have your own opinion on the 4% rule; whether that opinion is similar to Mr. Milevsky’s or whether you feel the rule has practical application for you, as a starting point for your

retirement calculations.

Conventional Wisdom – The 4% Withdrawal Rate

The 4% rule is a planning guideline for a sustainable rate of spending over a 30 year retirement. Years ago a brilliant financial planner by the name of William P. Bengen (an MIT graduate in Aeronautical Engineering) got tired of being asked how much money his clients needed to retire, so he initiated a study that basically concluded that if you retire with a diversified portfolio split 50/50 between bonds and stocks, you will be able to safely withdraw 4% of the initial balance, plus an inflation adjusted amount for the next 33 years and quite possibly as long as 50 years.

For example, if you have $800,000 when you retire, under the 4% withdrawal rate you can take out $32,000 the first year. If inflation is 2%, your second year withdrawal amount will be $32,640 ($32,000 + 2% x $32,000). If inflation is 1.5% in your third year, your withdrawal will be $33,130 ($32,640 x1.015%) and so on. It is important to note, this is not a percentage of portfolio withdrawal method where you take the ending balance at the end of each year and draw 4%; but is a consistent withdrawal amount based on your original nest egg adjusted for inflation each year, which some experts find distasteful.

If you wish to read Mr. Bengen’s initial paper, here is a link to his October, 1994 paper in the Journal of Financial Planning. It should be noted that in a subsequent study, Mr. Bengen added U.S. small-company stocks to the mix, which increased the portfolio's volatility and potential return. To adjust for this, he revised the withdrawal rule to 4.5%. However, I will continue to use the more conservative 4% withdrawal amount for discussion purposes.

So what does Bengen say today, with our historically low interest rates? In this MarketWatch article by Glenn Ruffenach, the author says “Bengen has never claimed that his findings are right for every retiree. Indeed, he thinks some of the latest research about market valuations is terrific."

                                                                                

Ruffenach goes on to say “He told me recently that he  started with a specific set of assumptions: a retirement lasting 30 years, with savings in a tax-deferred account and nothing left for heirs. Change just one of those parameters, he says, and your "safe" withdrawal rate may differ. Still, Bengen notes, 4% remains a prudent jumping-off point for calculating withdrawal rates from nest eggs. Just keep your plan open to some adjustments.”

In this 2012 paper written by Mr. Bengen, he discusses some contingency planning, which includes potentially reducing spending and increasing income.

Mr. Bengen did not provide a detailed summary of the market returns he used in his calculations, although he provided some returns for certain extrapolated years (10.3% for stocks, 5.2% for bonds and 3% inflation ). However, in this article by Joanna Pratt, she suggests that the 4% spending assumptions are based on a 9.2% stock return, 6.85% bond return and an inflation rate of 3%.

The Trinity Study – Support for the 4% Withdrawal Rate

A subsequent study, known as the Trinity Study by Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz supports Bergen’s assertions. Some critics say this study supports Bengen because they use the same flawed data. Their 1998 paper can be found here. 

The Cooley, Hubbard and Walz study produced a number of conclusions, including:

• Early retirees who anticipate long payout periods should plan on lower withdrawal rates.
• Bonds in the portfolio increase the success rate for low to mid-level withdrawal rates, but most retirees would benefit from allocating at least 50% to common stocks.
• For stock-denominated portfolios, withdrawal rates of 3 to 4 percent represent exceedingly conservative behaviour and will likely leave large estates.

The authors comment that if history is any guide for the future, then withdrawal rates of 3-4% are extremely unlikely to exhaust any portfolio of bonds and stock (in almost any combination).

But what happens to your retirement planning if stock market history does not repeat itself? Poor stock market returns for the last few years (until last year), countries defaulting or close to defaulting, historically low interest rates and tough economic times have caused some pundits to say we are in different times and the 4% rule is outdated, as it only captures periods of great prosperity. In part three of this series, which I will post next Monday, I discuss Moshe Milevsky’s unique retirement calculations and then the various modern studies and reports on what is the proper withdrawal rate upon retirement.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 1

Let’s be honest. No one knows how much money they really need to retire. My own attempt to quantify my “retirement number” results in a range of hundreds of thousands of dollars. Unless you fancy yourself a two-headed economist/soothsayer, you can only plan based on historical investment returns, anticipated spending requirements and assumed inflation rates. That does not even account for wild cards such as your longevity and the random sequence of returns you will get from the stock market. The best laid retirement plans of mice and men can often go awry… when bam -- you get a sudden economic shock or stock market aberration and your retirement plan becomes as worthless as the paper you wrote it on (those of a cynical nature have be known to say; all any retirement plan proves is ink sticks to paper).

I’ve been pondering this question for over a year as I have attempted to figure out the nest egg I need to fund my own retirement. My final conclusion: the financial and economic variables you need to consider to even attempt to answer this question are staggering (I detail these in Part 5 of this series) and I will never come to a definitive answer. This realization is actually liberating yet frightening. Liberating as I realize the best I can do is to create a plan that is based on a framework of historical data, actual data and my best guess estimates. Frightful in the sense that I may not know until it’s too late if I have grievously miscalculated my retirement needs. While going through this nest egg building process, I made some notes and read various papers. I soon realized I had a blog post in the making; in fact a six- part series that I will post throughout February.

For some, this series may be far to detailed. For others, these posts will provide food for thought. For the mathematicians and academics out there, the discussion will not be “academic” enough (although the problem with many academic papers is that only the author and other retirement/mathematical experts understand what the heck they are proposing). However, in all cases, despite the difficulty I see in making a definitive determination of how much money you or I need to retire, burying your head in the sand and ignoring the issue is not an option. It is imperative you try and at least get a ballpark number for planning purposes and continuously refine that number over time. I hope this series of blog posts will provide you the impetus to plan for your own retirement if you have not yet done so.

So where does one start? The 4% withdrawal rule is one of the most commonly accepted rule of thumb retirement strategies. Simply put, the rule says that if you have an equally balanced portfolio of stocks and bonds, you should be able to withdraw 4% of your retirement savings each year, adjusted for inflation, and those savings will last for 30-35 years.

If you embrace this rule of thumb, then in theory you should be able to determine how much money you need at retirement by working backwards. Unfortunately, as I will discuss, it is not quite that simple. The 4% withdrawal rule has some inherent flaws which I discuss below and therefore should only be used as part of your retirement framework to provide you an idea of what would be a sustainable nest egg.

Whether the withdrawal percentage is reduced from 4% to 2%, or you modify the formula, everyone is still searching for the holy grail of retirement planning, that being, what is your safe withdrawal rate? I.e.: How much money can you safely withdraw from your nest egg each year and not run out of money before you pass away.

Some retirement experts feel the search for a safe constant withdrawal rate is a foolhardy. In this Toronto Star article, Moshe A. Milevsky, a well-respected finance professor at the Schulich School of Business at York University says the following:

“If the rule means that you start by withdrawing 4 per cent of the value of the portfolio at retirement — and then adjust that by inflation every year regardless of how markets perform over time, then it is a horrible rule of thumb. The spending rate over time should depend on the markets, interest rates, how your portfolio is performing and your attitude to longevity risk. You cannot pick a rule at the age of 65 [and say] that is how you will behave over the next 30 years.”

Mr. Milevsky has some very interesting original thoughts on retirement that I discuss in the third part of this series. In fact, if you agree with his views, I tell you to exit the series at that point and return for Parts 5 & 6. Notwithstanding his comments (which I believe have validity), because of the simplicity of the calculation, many people and Financial Institutions still feel the 4% rule is an excellent starting point in the determination of your retirement nest egg if you understand its limitations and flaws. I agree that this rule is simple to apply and understand and thus over the next few posts, I will discuss various studies and papers that deal with the determination of a safe withdrawal rate and whether 4% is a safe withdrawal rate in this day and age. Finally, I will discuss variations of the rule put forth by retirement experts to adjust/correct for the perceived/flaws of the rule of thumb.

Limitations of the 4% Rule

Some of the criticisms of the 4% model include:

1. The model does not account for income taxes on non-registered accounts and registered accounts. Michael Nairne in this National Post article descriptively calls the deferred tax liability on registered accounts

the “Dark Side” of RRSP’s.

2. The model does not account for transaction fees or management fees related to your investments.

3. The model treats everyone exactly the same.

4. The data for the model was based on only historical U.S.stock data and does not include foreign equity data.

5. The model builds in an inflation adjustment; however, some commentators feel the cumulative inflation adjustment may force you to take larger and larger withdrawals.

A Tax Centric Variation on the 4% Withdrawal Rule

As result of the omissions above, especially the income tax component, I created a very crude tax centric variation of the 4% rule to provide an alternative comparison to some of the other retirement formulas I discuss in Part 6. (Please note I said crude and tax centric. When I posted last Monday I was going to run this series, I got various comments on the blog and to my inbox that people were excited to see what I came up with and did I use a Monte Carlo simulation etc. I do not have the qualifications, let alone the time, to run statistical simulations to come up with a unique formula that like every other formula will be flawed because of the unquantifiable variables that must be considered in determining your retirement number).

Now that I have dampened your expectations for my crude variation, I simply determined my spending requirements in retirement and subtracted from my spending requirement, my estimated sources of income outside of retirement (Old Age Security, CPP etc.) which results in a retirement withdrawal shortfall.

Here is where my calculation gets tax centric. I first calculate the income tax owing on my total estimated retirement income. This tax liability causes my retirement shortfall to increase. The next calculation is a bit circular, but I then come up with a revised withdrawal amount that after-tax covers my anticipated spending shortfall.

I then divide my required retirement after tax withdrawal above by 4% (3% for a conservative approach) which tells me how much money outside of any CPP, OAS or company pension (which I don’t have) I need to accumulate for retirement. When I post actual numbers in part 6 this will be much easier to follow and make a little more sense.

This crude estimate will give mathematicians heart palpitations. I know this tax centric variation does not address multiple issues, but bear with me until you see where I go with this in Part 6.

In no way should you rely on this framework as the sole determinant for your own retirement planning. However, as you will see in my last blog post, this number is not that far off from what I get when I have a financial planner use his software to provide me with “a number” and the number I get when I compare to some other calculations suggested by retirement experts.

I feel like a Lawyer with all these Caveats

One last final caveat before I discuss some data and analysis. Please be aware that I am not a retirement expert, financial planner, mathematician (I dropped statistics in University), or a psychic and understand this series should not be construed as specific personal retirement planning advice. The intention of this series is to:

• summarize prior research (the information is overwhelming and the arguments made by some brilliant people, hard to disprove)

•  assist you in determining your safe withdrawal rate percentage or provide you with an alternative method to the constant withdrawal methodology

•  provide links to the articles I read

•  share my thought processes in trying to determine my own retirement needs

Hopefully all this will provide you with a launching point to help you consider what may be a reasonable retirement nest egg and/or a reasonable spending amount for your retirement.

On Wednesday I discuss the history of the 4% withdrawal rate rule of thumb in greater detail.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.