In today’s Lifetime Income podcast, Jim Puplava and Laurence Kotlikoff explain how long-held retirement rules of thumb are failing to meet the needs of individuals in today’s world.
According to Kotlikoff, “conventional financial planning is asking the wrong questions, using the wrong methods, and is wholly unable to provide appropriate personal financial advice.”
Two very common retirement maxims that Puplava and Kotlikoff take on are the four percent “withdrawal rate” and the 70 percent “replacement rate”.
Here’s what Investopedia says about the first:
“The 4 percent rule is a rule of thumb used to determine how much a retiree should withdraw from a retirement account each year. This rule seeks to provide a steady income stream to the retiree while also maintaining an account balance that keeps income flowing through retirement. Experts consider the 4 percent withdrawal rate safe, as the withdrawals will consist primarily of interest and dividends.”
And regarding the second rule, the Government Accountability Office states, “Generally, [the replacement rate] is calculated as the ratio of retirement income in the first year of retirement to household income in the year immediately preceding retirement,” with the Social Security Administration noting “most financial advisors say that you will need 70 percent or more of pre-retirement earnings to live comfortably.” (source)
Here’s what Kotlikoff says about these two popular retirement rules (see Kotlikoff: The Rules for Retirement Planning Have Completely Changed! for audio):
“Neither of these rules of thumb are useful because everybody's situation is so different and what might be the right ratio of spending to pre-retirement income for one household may be dramatically different for another.
Saying that everybody should target to spend 70-85% of their income during retirement...is off base.
What happens is that people keep their spending fixed, not their savings, and then they adjust their saving so they can keep their spending fixed. So the idea of putting your saving on auto-pilot means you are making consumption wiggle over all the place and that's the opposite of what people want.
People don't want their living standard to be high this year and low the next year...they want to have a smooth ride and that's the whole reason why we're saving in the first place.”
Kotlikoff continues: “We don't need to use stupid rules or high school algebra to figure out our finances anymore. We have much more significant software out there. As you know, I've developed a program called Maxifi Planner, which doesn't give you a target or any rules of thumb to obey. It figures out what you should spend every year so that you can keep spending it.
When we’re talking about spending, we're talking about discretionary spending—what your real living standards is about—not about things that you have to spend money on like your taxes or your mortgage or work expenses...all those things are entered into the program and then it gives a path of discretionary spending that will maintain a living standard through time, solving the whole problem of how much you should spend every year.”
We discussed how two common rules of thumb for retirement planning don't often apply to the unique needs and circumstances of individuals. That said, are there any rules or principles that our listeners should keep in mind when planning for retirement?
“Well, they should figure out first how to not retire because retirement is very risky and science could discover a cure for cancer or other age-related disease and we could end up living to 150, so you want to keep working because every year you keep working is a year less that you have to use up your savings—that's rule number 1.
Rule number 2 is you have to have a plan for how much you should be spending and saving and not be overspending...
Rule 3 is you need to make sure you are maximizing your tax savings through retirement accounts, either a 401(k) type of account or traditional IRA or a Roth IRA, depending on what is going to produce a higher path of spending.”
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