Enhancement 4: Knowing How Much Income to Draw
As important as the first three enhancements are, they are practically useless if you draw too much or too little income. In the case of the Thompsons, they drew income from all sources of $62,500 in the first year of retirement. This turned out to be just about the right amount for them based on their spending shocks and poor investment returns, though it would have been too much if they hadn’t adopted the three enhancements.
What is a little mind-boggling is how a small change in the amount of income being drawn can have such a major impact over the long term. If the Thompsons had started out by drawing just $60,000, they would have had about $160,000 left over at age 95. If their initial draw had been $65,000, they would have run out of money around the time Nick turned 80.
The big question then is how do you establish how much income you can draw from your savings? Equally important, how do you modify the amount you draw over time if your experience is better or worse than you expected? If this is hard to figure out in a simple situation, like that of the Thompsons, how do you cope with a more complex situation, say where you have other sources of income that might vary from year to year, like part-time employment, rental income, investments outside of a tax shelter, money released by downsizing one’s home, or a sudden inheritance?
Retirees wrestle with this dilemma all the time. Surveys suggest that most of them resolve the situation by being very conservative in how much they spend. Most people try to avoid touching their capital if they can help it and spend only the investment income. Sure, they would like to spend more, but not if it’s going to lead to constant anxiety about a possible future bankruptcy.
This brings us to Enhancement 4. Unlike the previous three enhancements, which all involved ways to stretch one’s retirement dollars further, Enhancement 4 is about determining how much income one can draw in retirement. It involves using a retirement income calculator to determine the initial income amount.
Besides determining how much income you can draw in the first year of retirement, Enhancement 4 also involves adjusting that amount in subsequent years as your circumstances change. The idea of actively adjusting your spending — up or down — to reflect your ever-evolving financial situation is essential to a successful decumulation strategy. This is what lies at the heart of Enhancement 4.
Remember that the Thompsons incurred some spending shocks as well as some very poor investment returns. If their luck had been better, Enhancement 4 would have allowed them to draw more income later in retirement. If the spending shocks had been deeper or more frequent, they might have had to draw less. The same sort of adjustments would take place if their investment returns were better or worse than expected.
Enhancement 4 involves using an online retirement income calculator to determine how much income can be drawn from all sources. For this purpose, I created something called PERC, which is short for Personal Enhanced Retirement Calculator. I developed PERC based on the ideas presented in this book, and I employed the services of Morneau Shepell’s extensive IT team to make it a reality. PERC is available to the public at no cost and no obligation. Below, I explain how to access PERC and describe in more detail how it works.
To find PERC online, type in PERC.morneaushepell.com in your browser and hit Enter. On the first page you will find a description of PERC, which explains that the user needs to be between ages 50 and 80 to use it. If you are younger than 50, be happy about your relative youth and wait a few years. The other requirement is that the user must be retired or within ten years of retirement. Remember that this book is for people who are close to retirement, not those in mid-career.
The first step is to read the terms of use, click on Agree, and then click on Next. Note that you do not have to provide your email address and, as mentioned earlier, there is no charge to use PERC. My friends at Morneau Shepell have made PERC available to the public, and it is important to me that it be easy to access without the user having to worry about a sales call or ending up on some telemarketer’s mailing list.
On the next few screens, you need to enter some basic financial information about yourself. Since you do not divulge your identity anywhere, the information you entered is kept totally confidential. In fact, the system discards your entries after you have finished.
Some of the fields must be completed, and some of them should be kept blank if they do not apply to you. There is a question mark beside most of the boxes where you enter data: click on it and you will see a more detailed explanation on how to answer the given question. In addition, you can refer to Appendix C for more information on how to complete the boxes.
I apologize for the amount of data you have to enter, but it is essential if you want a meaningful answer to the question of how much income you can draw. Once all the data is entered and you press Next one final time, you will see a summary screen that explains that results have been prepared under three scenarios as follows:
|
Scenario |
Description |
|---|---|
|
1 |
Worst-case (5th-percentile) investment returns and assuming you do not adopt the enhancements |
|
2 |
Worst-case returns but assuming you do adopt the first three enhancements |
|
3 |
Same as Scenario 2 except you enjoy median investment returns (which average out to about 5 percent a year) |
Scenario 1 is your base case. It assumes your investments do poorly and that you do not adopt any of the enhancements. PERC shows the results under Scenario 1 so that you can see later on how much better you can do by applying the strategies in this book.
Scenario 2 tells you the least amount of income that you should be able to draw safely, even if your investments do very poorly. It applies if you adopt the first three enhancements described in the preceding chapters.
Scenario 3 is more optimistic and assumes median returns on your investments. That is why it shows a higher income level. As long as you use PERC regularly (say annually), you should feel safe drawing income based on this scenario.
To summarize, you should be able to make your savings last a lifetime if your future spending shocks are not too onerous and you keep the total income you draw each year somewhere between the figures produced by Scenario 2 and Scenario 3.
I cannot claim that PERC is the best retirement income calculator out there, but it almost certainly is the only one that explicitly takes the first three enhancements into account. I strongly recommend using PERC on a regular basis.
When the Thompsons input their data into PERC, Scenario 2 shows them that they could draw total income in year 1 of just under $62,900, which is a little more than the $62,500 we have been using in our examples. Under Scenario 3 (median returns), the Thompsons could draw total income of $70,200. If they don’t want to be forced to reduce the amount of income they draw in future years, they might opt to draw an amount closer to $62,900 than to $70,200, but any number in this range is fine as long as they can reel in their spending if things go badly. What is important is that they use PERC regularly to confirm that they are still on the right track.
Enhancement 4 may not seem as dramatic as the other enhancements, but it is essential. Without it, you really cannot know how much income you can safely draw.