Rutgers New Jersey Agricultural Experiment Station [Later Life Farming]

Module 7d: How Long Will Your Money Last?

The term "safe withdrawal" refers to the amount that retirees can withdraw from retirement savings without running out of money during a specified period of time (e.g., 30 years). Key factors in determining a safe withdrawal rate are the amount of accumulated savings, the number of years that assets are desired to last, and the asset allocation (i.e., percentage of savings in stocks, bonds, real estate, and cash assets) of a retiree's investment portfolio. Several factors are, of course, unknown, such as a person's actual life expectancy and return on investments.

In recent years, retirement withdrawal scenarios have been studied using a technique called Monte Carlo simulation. Thanks to advances in computer science, it is possible to quickly and inexpensively compute the probability of various outcomes, including the odds of having retirement assets last a specified number of years. Monte Carlo simulations calculate probabilities for thousands of possible scenarios using data about the past performance of assets such as stocks and bonds. They are widely used by financial services firms to advise clients on safe withdrawal rates, although, like any type of computerized calculation, results depend upon the accuracy of inputted data and the underlying assumptions.

You can find online Monte Carlo calculators by typing the words "Monte Carlo calculator" into an internet search engine such as Google. Most online analyses provide a short sentence or two that describes the probability of "success"; i.e., not running out of money. For example, "Success Rate: 46% chance that your investments will last 30 years." Some calculators provide even more detail such as the average length of time that a portfolio will last and probabilities that savings would last between a range of time periods (e.g., between 25 and 30 years).

As noted in Module 1a, the standard financial advice for someone planning on 30 years in retirement is to withdraw 4% of retirement savings in the first year of retirement (e.g., 4% of $500,000 is $20,000) and increase the withdrawal amount by 3% annually to keep pace with inflation. Using one Monte Carlo calculator, if someone retires with $1.5 million in retirement assets and withdraws 4% ($60,000) during the first year of retirement from a portfolio consisting of 50% stocks, 30% bonds, and 20% cash, savings is projected to last 34.12 years, on average, with a 95% probability of lasting between 28.42 and 39.82 years. Bump the annual withdrawal up to 5% ($75,000) and invested assets are projected to last an average of 32.03 years and fall between 21.74 and 42.33 years, a much wider range, 95% of the time.

Stated another way, the failure rate (i.e., probability of running out of money) is higher when the percentage of assets being withdrawn from a retiree's investment portfolio increases. A high probability of failure, particularly when someone performs simulations using several online calculators and gets similar results, is a wake-up call and indicates that additional retirement "catch-up strategies" (e.g., working longer) may be in order.

Given the relative ease of performing Monte Carlo simulations with historical investment data, as well as the "graying of America," there has been an increasing amount of research during the past 15 years about sustainable retirement asset withdrawals. Academics and financial services firms alike have conducted studies about how long retirees' assets will last.

Of course, past investment results, upon which Monte Carlo simulations are based, are no guarantee of investment performance in the future. Nevertheless, most experts caution against withdrawing more than 4% to 5% of invested assets (regardless of the amount) if you are concerned about making your money last a lifetime. In addition, to further increase the probability of making your money last, some investment advisors recommend forgoing annual inflation adjustments to retirement income withdrawals during extended market downturns.

Of course, this discussion of making annual income withdrawals assumes that provisions are made to convert a farmer's largest (and very illiquid) asset, farm land and equipment, into some type of investment from which structured withdrawals can be made. This may involve selling or renting out farm land, holding a mortgage for a buyer, selling shares of stock in a farm corporation, or other types of property transfer arrangements. Be sure to consult with a lawyer and/or financial planner for the best procedures to use in your specific situation.

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