Lately, I've been obsessed with the study of running out of money in retirement, a condition I described as "range anxiety." I borrowed this term from the electric car industry where they use the phrase to explain why electric cars don't sell very well, yet.
People are paranoid about getting into a car that might run out of juice, juice for which there is no quick, easy replacement.
Armed with a clutter of Excel spreadsheets, I've concocted some models that outline what can happen at a variety of retirement fund extraction rates and the results are illuminating. I used $500,000 as probably a reasonable number for folks to have in their retirement plans combined.
Today's average or median is hard to determine exactly, but our experience is that people in the mid-fifties have roughly half that amount. This means that by the time they retire, with 10 years of compounding and additional deposits, the $500,000 figure is reasonable.
So, what happens if our $500,000 (in bonds) is earning 6 percent per year in interest and we decide to start eating into the principal for additional support beyond just the interest earnings?
At a starting extraction rate of $60,000 per year, reduced each year by declining interest earnings, we run completely out of money in 16 years.
If we write ourselves a check for $30,000 of principal and spend the interest as it is paid during the year, things actually work for awhile.
Our interest earnings start dropping as the principal is depleted, but our $30,000 bonus plus interest is still totaling $42,000 after 10 years. Then the account falls off a cliff. Four years later, there's no more money. The $500,000 is gone.
If we pay a principal bonus of only $15,000 instead of $30,000, the picture is entirely different.
At the end of 15 years, we still have about half the money left, about $260,000.
That money completely disappears after about another 10 years, but by then we may be well into our nineties depending upon when we retired.
If this is roll-over IRA retirement plan money we are spending, all of it is taxable as regular income.
It pays to remember that once a couple has adjusted gross income in the area beyond $60,000, then every additional dollar will be taxed here in California at 30 percent or more.
Taking more money out of these retirement plans beyond a certain point is counterproductive when we consider that dialing out those extra dollars generates the last few dollars which will be taxed at our highest marginal tax rates.
It pays to think carefully about whether that money is being well spent because the cost of every additional spendable dollar triggers 50 cents more in additional taxes.
There is probably an argument for our spending more retirement money early when the combination of youth and better health enable us to enjoy the leisure we have created.
However, when we see these spending models heading over a cliff about 10 to 15 years out, it would make sense to have a realistic back-up plan.
A cutback in spending, a part-time job, or the sale of a house should be somewhere in the contingency plan. What's surprising about these calculations is the sudden acceleration of disappearing capital.
In the early years, even with substantial distributions, the account doesn't drop by much for a few years, but this is a seductive trap.
It's the magic of compound interest in reverse when we chew into that principal.
Meanwhile, there is no magic bullet in the way of an investment product that will give you the same level of control and flexibility that comes with managing your own assets carefully.
Be wary of that exhilarating "high" that comes from someone telling you exactly what you want to hear.