The Five Biggest Myths of Retirement Planning

Daniel B. Eagan

In the world of retirement planning, some myths persist, despite continued efforts to debunk them. Below, my colleague Tara Thompson-Popernik discusses a few of the most stubborn myths we encounter.

1. You can safely withdraw 4% of your portfolio a year in retirement

The “4% rule” may have worked in the past, but extremely low bond yields, below-average expected returns for stocks and increased longevity make a lower spending rate prudent for many retirees.

For a newly retired couple aged 65, with a retirement nest egg invested in a balanced portfolio (60% stocks and 40% bonds), we would generally recommend annual spending equal to about 3% of their portfolio at first, but increase that amount with inflation. A couple aged 75 could generally afford to spend closer to 4% of a balanced portfolio each year, because their life expectancy would be shorter. All else equal, their portfolio would have to support their spending for approximately 10 fewer years.

2. You’ll spend less in retirement

In early retirement, retirees often spend more than they did while working because they have more time to pursue a hobby or travel, although they expect this initial spending increase to subside as they age. But many retirees we encounter maintain an active lifestyle longer than they anticipated; that extra spending puts a strain on their retirement savings.

In addition, two great unknowns loom large for many retirees: how much they’ll have to spend long term on healthcare and how long their life span may stretch. We tend to caution our clients to anticipate spending at least the same amount, adjusted for inflation, as they move from their 60s into their 70s and 80s.

3. Always shift to bonds as you age

Bond yields at or near historic lows and increasing longevity (many retirees live for three decades after they collect their last paycheck) make a complete shift to bonds unwise for most retirees. Most investors will need the growth that stocks can provide to keep pace with inflation and to support their lifestyle in retirement. The precise amount will vary for each individual, depending on his or her circumstances, objectives and risk tolerance.

4. Take Social Security early

In the US, Social Security benefits can be drawn as early as age 62, and the majority of recipients begin taking payments at that point. But the Social Security Administration has created an incentive for workers to wait to begin drawing benefits until age 70, when benefits peak. For recipients born between 1943 and 1954, the benefit at age 62 is some 25% below the payout at their “Full Retirement Age” of 66. Conversely, between ages 66 and 70, recipients earn delayed retirement credits of 8% per year.

For retirees who expect their portfolios (and perhaps pensions) to meet their spending needs for life, the age at which they begin to take Social Security benefits doesn’t matter much. But for healthy retirees whose spending is higher than their portfolio is likely to sustain, it is often advantageous to wait until age 70 to start collecting benefits. The accumulated delayed retirement credits plus the inflation adjustment to the retiree’s higher benefit amount can make a big difference in the retiree’s ability to spend in old age.

5. Deferring taxes is always a good idea

The conventional wisdom is to defer taxes whenever you can. But federal income and capital gains tax rates are scheduled to rise at year-end unless Congress acts. For retirees (and other investors) facing a potential rate hike, it may make sense to pay lower taxes this year than to pay higher taxes in the future.

For example, now may be a great time for those who hold appreciated positions in the stock of a former employer to realize the gain and diversify that concentrated stock position. The same is true for those who still hold stock options in their former company’s stock.

Also, retirees who don’t expect to spend down their IRA accounts during their lifetime may want to convert all or a portion of their IRA accounts to a Roth IRA. As part of the conversion, the retiree will pay taxes now on the converted amount, but the account owner or, potentially, the owner’s surviving spouse or heirs, can withdraw assets from the Roth tax free later.

The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

Daniel B. Eagan is the Head and Tara Thompson Popernik is the Director of Research of the Wealth Management Group at Bernstein Global Wealth Management, a unit of AllianceBernstein.

7 comments

  1. You are spot on. Great points.

  2. The concept that a person should only take 3% from a retirement portfolio appears to me as silly as the idea that one should take 8% that was in vogue back in the late 1990s.

    All we have to use to judge the likely future is the past. In the past when stock market returns were effectively zero for a decade or more, as they are today, reversion to the mean created an outsized gain in the following decade. I can find no point in history where that does not apply.

    Even if we compare 2007-2009 to the market decline of 1929-34, five years after the high point, just when the gloom and doom was the worst, was a point from which equity gains were astonishingly high for the next two decades.

    To tell people who have had little or no real gain in their portfolios that they must learn to live on 3% of what they have saved is to drive them into the arms of the shysters who will take all of their money. A well allocated portfolio right now has a good potential of achieving a healthy 8% (+) expected return for the next several decades.

    • Tara Thompson Popernik

      We””d agree that today””s high equity risk premium means that equities are well-positioned for positive returns. But, because bond yields are so low, we expect total equity returns to be muted compared to what history would suggest about a post-crisis period. In other words, we believe equities will deliver returns near their long term normal returns while bonds will deliver returns far below long term averages. For a retired investor in a balanced portfolio, this means returns will be lower than normal.

      It””s also important to note that the initial sustainable spending rate of 3% for a 65 year old couple is designed to give retirees a high degree of confidence that they will be able to spend an inflation-adjusted after-tax amount from a balanced portfolio for the rest of their lives. We define a high degree of confidence as a 90% likelihood of not running out of money during your lifetime. A less conservative planning standard would result in a higher sustainable spending rate.

  3. Russell D. Ragland

    Generally good advice and much appreciated.

    Obliviously, as one ages their life expectancy declines so the total portfolio requirements should decline as well.

    I am wondering how much where one is in the market cycle (peak or trough) and having a personal goal of leaving as little as possible would influence the 3% or 4% rule?

    The real point is everyone”s needs are different and one has to constantly adjust to the short-term and long-term circumstances in making this important decision.

  4. David Forman

    I believe that if one wishes to maintain his or her standard of living and a portfolio that does not lose any capital, one must consider taxes and inflation. Assuming your 3% to live on, you must add say 2.5% for today”s inflation and divide by a tax rate say of 0.7%. This would require a return of nearly 8%. This would allow you to 1) increase your annual expenses to stay even with inflation, pay your taxes and keep your portfolio growing at the rate of inflation. I know, I for one, feel very uncomfortable in running down my portfolio to zero on the day I die (guarantee to cause death on that day)! Also, I would like to have some Estate to pass on to charity and my children. To get a return of 3% today would be very unsatisfactory.

  5. Hi Daniel B. Eagan
    It”s true fact you have written and great idea.I appreciate your thoughts.I just want to put another point here.
    Many banks and building societies take every possible opportunity to promote their financial products, such as pensions. It all sounds very good and many people choose their bank to provide their pension as they trust them, but it should be realized that they are usually tied in to promote only one pension provider and this will rarely offer the best opportunity out there.

  6. One more myth “My retirement years won”t last all that long” :)

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