March 13, 2012
Next, I prepared Figure 2, assuming a 30-year retirement beginning at age 65. Subsequent spending is calibrated to the age-65 level, and, following Bernicke, real spending declines gradually to a point that is 33% less in real terms at age 75 than it was at age 65. It then stays at this lower real amount until age 95.
Figure 2 shows the historical maximum sustainable withdrawal rate based on the underlying assumptions (including constant inflation-adjusted spending needs) in William Bengen’s classic 1994 article, Determining Withdrawal Rates Using Historical Data, which I recently summarized on my blog. Over time, Bernicke’s lower spending needs result in sustainable withdrawal rates that are between 1.3% and 2.4% higher than those required to maintain constant inflation-adjusted spending. For both spending assumptions, the worst-case scenario happened in 1966. Bernicke’s spending assumptions would have supported an initial withdrawal rate of 5.55%, compared to 4.15% with constant spending. For someone using Bengen’s historical worst-case maximum sustainable withdrawal rate as a spending guide, that implies retirement could have begun with 25% less wealth. This is not a trivial matter!
Is Bernicke correct?
I am not convinced that the spending reductions that arise with age are as large or as voluntary as Bernicke concluded. Bernicke makes the case that the reductions are voluntary by referring to data on median net worth by age and household-income quintiles to show that older people have more wealth than younger people within each quintile. If older people are wealthier but are spending less, he concluded that the spending reductions must be voluntary. Jonathan Clements raised a valid criticism of this, though, in a 2006 Wall Street Journal article. Those income quintiles are defined for the whole population, and a much higher percentage (43%) of the 75+ individuals are in the bottom-income quintile. This makes Bernicke’s comparisons between wealth and age somewhat less meaningful.
In a 2006 study for the National Tax Journal, I investigated income sources for the 90% of the elderly who receive Social Security benefits. I found that among the elderly, poverty does increase with age, and that those with less income are more likely to be unmarried females (mostly widows) who rely heavily on Social Security. Since Social Security is adjusted for wage growth prior to retirement but for inflation after retirement, older retirees will naturally have smaller benefit amounts than younger retirees, an important explanation for less spending.
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