Will Required Minimum Distributions Exhaust My Savings and Leave Me in Penury?

Abstract

This paper probes the question of how long retirement savings can be sustained under mandated withdrawals whose rate increases with age. It begins with idealized, constant rates of return typical of balanced funds. These laboratory analyses show that funds are unlikely to be exhausted before age 100, and that exhaustion, when it comes, occurs because of Bengen’s test, i.e., the eventual need to withdraw more than the minimum to maintain the initial age 72 income in constant dollars. Next, the paper examines sequence-of-returns risk using selected historical data. The worst decade for balanced fund returns in the US was located, but even with this bad start the crudest sort of balanced portfolio could still be made to sustain income to age 101. The paper proceeds to examine a variety of worst-case scenarios drawn from the two-century historical record, in the US and globally, with the worst cases ex-USA limited to markets not suffering a national disaster. In the US, it was always possible to sustain income to age 100. Globally, this could not always be achieved, with the worst shortfalls explained by either inflation or prolonged periods of depressed asset returns. In the 20th century US, the analyses find a 30/70 allocation to be inferior to a 60/40 allocation when the goal is to sustain inflation-adjusted income for as long as possible; globally and historically, that generalization did not hold. Next, the paper considers whether small changes to the balanced mix, consistent with those seen in Target Date Retirement funds, could improve outcomes; in all the cases examined, small alterations were able to improve the longevity of savings, sometimes dramatically. The paper ends on an optimistic note: two centuries of global market history indicate that exhaustion of tax-sheltered retirement savings before the age of 100 is unlikely to occur for retirees who model their asset mix after those seen in Target Date funds.

Keywords: retirement plans, sustainable withdrawal, RMD, historical asset returns, constant dollar income

JEL Classification: J14 ,J26, N11