Magazine article The CPA Journal

The 'Tighten Your Belt, Happy Beneficiaries' Retirement Strategy

Magazine article The CPA Journal

The 'Tighten Your Belt, Happy Beneficiaries' Retirement Strategy

Article excerpt

Balancing Withdrawals and Preserving Assets

A long-term financial plan must address a number of interlocking issues and concerns. The author counsels clients to use a "tighten your belt, happy beneficiaries" strategy that entails an equal percentage withdrawal of the beginning of each period's assets. When the market goes down, withdrawals decrease, and when the market goes up, more can be spent. The strategy adjusts for inflation and fees with equal purchasing power deposits and, as affected by market fluctuations, an expectation of equal purchasing power withdrawals during retirement. Following it can calm investors' fears when markets decline and prevent panicked investors from getting out of good investments at exactly the wrong time. In down markets, a safety valve can be implemented by projecting the maximum lifetime withdrawal period and, correspondingly, increasing the withdrawal percentage. Implementation can be done with index funds to minimize costs while maximizing return and minimizing risk, compared to managed funds.

To illustrate: If an individual using this strategy had $1 million in retirement assets at the start of retirement, and the withdrawal rate was 5% per year, then $50,000 could be withdrawn the first year of retirement. If, at the start of the second year of retirement, retirement assets had dropped to $900,000, the retiree would "tighten his belt," withdrawing only $45,000 (5%) in the second retirement year. If retirement assets then rose to $1.1 million at the start of the third retirement year, the belt would be loosened and $55,000 (still 5%) could be withdrawn that year. Every year, the 5% rate would be applied at year-end to the beginning of that year's retirement assets in order to arrive at the amount withdrawable in the following year.

An advantage of this method is that if a sufficiently small percentage of the retirement assets are tapped each year, the retirement assets themselves could remain largely intact. This is the "happy beneficiaries" part of the strategy. When a retiree dies, the remaining retirement assets pass to the retiree's heirs (or, as directed by the retiree, to charity, for example).

Historical Lessons

In applying the "tighten your belt, happy beneficiaries" strategy, it is necessary to have some idea about long-term financial trends. Exhibit 1 includes a graph going back to the beginnings of the financial markets in 1802 and extending to the end of 2006. The historical performance of world stocks, bonds, Treasury bills and gold is shown on the basis of $1 invested in each at the start of 1802. All dividends on the stock and all interest on the bonds and Treasury bills are assumed to be reinvested in the same assets. Taxes are assumed to be zero, and inflation is not taken into account. For comparison, the Consumer Price Index (CPI) is shown, with a starting value of $1 in 1802.

The table in Exhibit 1, a compilation of the annual rate of return, reveals several things. Inflation has averaged 1.39% per year over the 205 -year period, with $1 in 1802 having the same purchasing power (per the CPI) as $16.84 in 2006. Holding gold over the 205 years would have almost doubled that purchasing power, with an ending 2006 value of $32.84. But taking so long, the return would be barely above inflation at 1 .72% per year. The inevitable conclusion is that gold tends to hold its value over time but makes a poor longterm investment, with a paltry return.

Treasury bills, with a maturity under a year and U.S. government backing, are generally considered the safest investment in the world. A dollar invested in Treasury bills in 1802 would have grown to $5,061, for a return of 4.25%. Bonds, with their increased risk due to longer maturities and the possibility of default on non-U.S. government bonds, would have done better, with an ending 2006 value of $18,235 and an annual rate of return of 4.90%.

World stocks had an ending 2006 value of $12. …

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