Outside the Box: Why you should plan to leave money to your kids

From time to time I hear people say they want to “die broke.” I understand what it means: They want to use up their assets while they’re alive. But it’s a bad thing to plan for.

Because you don’t know how long your life will last, you have to assume that you’ll keep on living. And that means you need to keep money in your portfolio generating income and growth.

Read: Imagining your future self can help you plan for a better retirement

Financial planners of all stripes tend to recommend annual withdrawals of 3% to 5% of your portfolio’s value. If you can meet your needs taking out 3%, you’re in very little danger of running out of money.

If you take out 5% each year, you’ll probably be fine for a while. You’ll certainly have more to live on. But this level of withdrawals is less likely to be sustainable over a long retirement.

Read: The inventor of the ‘4% rule’ just changed it

For many years I’ve published and updated a set of fact-based tables showing hypothetical year-by-year results (starting in 1970) from various portfolios and rates of withdrawal.

If you click on this link you will find some of those tables. For this discussion I’ll refer only to the top four of them, Tables 10-13..

To quickly see how these work, start by scrolling down to Table 12.

The table has 10 columns, each of which shows year-by-year portfolio values for a particular percentage combination of bond funds and the S&P 500 index SPX, +1.09%.

In this table we assume you took out $50,000 (5% of your portfolio) in 1970 and then adjusted that amount each year to keep your spending ability up with actual inflation.

At a glance, you can see that the end-of-year portfolio values disappeared in each column, starting in the late 1990s.

Granted, these portfolios funded a lot of retirement years. But with increasing demands for annual withdrawals, they simply had to give up the ghost at some point.

This table (and others you’ll find in that link) have many interesting lessons to teach. But for now let’s focus on how much you should plan to take out each year to reduce your risk of running out of money.

Read: Save $1,000 a year, retire with millions

Scroll down to Table 13, and you’ll see the startling results of taking out $60,000 in 1970 (and adjusting for inflation) instead of 5%. This plan was able to fund 15 years of retirement (plus a few more in some cases). But after that, it went belly-up relatively quickly.

Table 11 shows the results of 4% withdrawals. You’ll see in an instant that none of those columns had any trouble continuing the payouts through 2020 — a very long retirement.

This is the result you want, and it would indeed let you leave money to your kids. If you scroll up to Table 10, you’ll see that 3% withdrawals would have let you leave extremely generous bequests.

This choice of your annual withdrawal rate should normally be determined by how much you need from your portfolio when you retire.

If you have substantial savings and can get by with 4% or less, you are likely to be in very good financial shape. But if you need to start by taking out 5% or more, your prospects aren’t quite that sound. In this case, you may want to consider postponing your retirement if possible and/or find a way to earn some extra money while you’re retired.

As we have seen, the percentage you withdraw from your portfolio each year is extremely important. But as you can see plainly in Table 12, some columns ran out of money much sooner than others because they had different proportions of equity funds and bond funds.

For the sake of longevity, the “sweet spot” seems to be portfolios that hold 40% to 60% of their assets in equities.

There are some tricky trade-offs associated with this topic.

For example, some people are quite risk-averse when it comes to holding equities in retirement. According to these tables, they could have done just fine with the 4% withdrawals while limiting their equity exposure to 40% or less.

However, the low equity exposure bought those investors only peace of mind, not more money to spend in retirement.

Before I briefly discuss the idea of “I want to die broke,” here’s my bottom-line advice when you’re planning retirement withdrawals.

Most important of all, start your retirement with as much money as possible. In this article, I argue that many people could effectively double their retirement income by postponing it five years.

Second, plan to live a bit below your means. No matter how much you take out of your portfolio every year, see if you can meet your needs and still live a good life by spending a bit less than you have available. That will build in a bit of cushion for extra expenses to deal with various needs and opportunities that are sure to arise.

Third, if you’re unsure about all this, enlist the help of a financial adviser who does not have products to sell and who is a fiduciary.

Do you still want to try to live until you’re broke (and in the process disinherit the kids)?   

In an article late last year, I discussed a reliable way to do that using a single-premium life annuity. An insurance company will take your money (permanently) and in return will guarantee you a monthly income for as long as you live.

With this arrangement you can’t outlive your money. However, this is a permanent decision, so don’t do it unless you are sure you understand what you’re doing.

One interesting “hybrid” approach, if your savings are ample, calls for buying an annuity that will meet your basic needs and then spend the rest as you like.  

Even then, I think your best bet is likely to be planning to have some money left over to leave to the kids.

This discussion is based on many tables that over the years have helped thousands of investors figure out what they need to save, how to fine-tune their investment risk and how to plan for withdrawals.

To learn how to get more from these tables, check out my podcast about fixed distributions. And early next month, I’ll write about how to safely take more from your retirement portfolio.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.