You've Saved It. Now, How Do You Spend It?

There are no reliable rules for making money last a lifetime

If you’ve socked away plenty of money in your 401(k) plan and invested it carefully, congratulations. Now comes the real challenge. For retirees, choices about how to spend a lifetime’s savings are fraught with tricky calculations about market risk, taxes, and death.

Jim and Sue Cleary, both 69, have two homes, one in Florida and a second in western Michigan that keeps them close to five of their nine grandchildren. And yet, as they attend the kids’ football, basketball, and soccer games, Jim says he knows they won’t be able to maintain this lifestyle indefinitely. To reduce expenses, the Clearys have already stopped going on cruises to Alaska and Australia, and they know they may eventually have to sell one of their homes. Even though they’re careful planners, they’re struggling with a basic question: spend now to enjoy their healthy years and risk running out of money, or scrimp today for a tomorrow that may never come or come only when they’re too infirm to savor it? “That’s kind of the main concern I have—are you going to outlive what you have?” Jim says.

It’s a worry echoing across the Baby Boom generation, which includes the first retirees leaning heavily on 401(k)s and other defined-contribution plans. An old-style pension is guaranteed to last as long as the recipient lives. With 401(k)s and their ilk, it’s up to the individual to figure out how to make the money last. There are lots of unknowns to grapple with. Retirees, especially those who can’t go back to the workforce, have to think about the effects of increases in the cost of living, what they want to leave for their children, how much they’ll spend on health care, and when they’ll die. “People are undercalculating the level of risks and longevity they need to save for,” says Sri Reddy, head of full-service investments at Prudential Financial.

It isn’t easy to look at a large balance in a retirement account and translate it into an annual allowance. “There’s sort of a money illusion when you have a big lump sum of money sitting in your 401(k) account,” says Jonathan Forman, a law professor at the University of Oklahoma who studies retirement policy. “You think you’re rich.”

While financial advisers have a lot to say about the best ways to save for retirement, far less guidance is available for making the money last. Many retirees, including the Clearys, rely on the familiar rule of thumb that says it’s safe to spend about 4 percent of your retirement stake each year. The 4 percent rule worked better in an era of higher interest rates, though, when relatively safe investments such as certificates of deposit and short- and intermediate-term government bonds could return 4 percent or close to it. For the past five years, retirees who put their money in safe investments have earned almost nothing in interest.

Adding to the uncertainty, people are living longer. American men who reach age 65 will live an additional 17.9 years on average, while women will live 20.5 years more, according to 2012 data released this month by the Centers for Disease Control and Prevention. Since 2002, average life expectancy at 65 has increased by 10 percent for men and 7 percent for women. The problem will become more pronounced over the next few decades as more workers retire without defined-benefit plans and life expectancies continue to increase.

Retirees who have the bad luck to stop working just before or after a few bad years in the markets can suffer permanent damage to their nest egg. To illustrate the problem, Russell Investments created two hypothetical retirees who each had a $1 million account; earned an average of 7 percent on their investments over 20 years; and made the same annual withdrawals, starting at $50,000 and increasing them 3 percent a year to keep up with inflation. One of the retirees had mostly positive returns in the early years, with losses concentrated in later years, leaving $1.7 million after 20 years. The other, who had the same annual returns but in the opposite order, ran out of money by year 19.

The government, which created 401(k)s and other tax-deferred accounts, offers little guidance for making the money last. The minimum distribution rules for retirement accounts, which require retirees to withdraw money starting after age 70 ½, are meant to make sure people pay taxes on savings they accumulated tax-free—they are not designed as guidelines for spending.

The Department of Labor said in 2013 that it would propose formal rules requiring 401(k) providers to show people how long their money will last under various scenarios, something many already do. The department has not done so yet. President Obama has proposed eliminating required distributions for people with account balances of less than $100,000 so they can continue to accumulate tax-deferred savings. That proposal is bogged down in the debate over revamping the U.S. tax code.

While the government “is increasingly focused on helping individuals manage” their retirement assets, Mark Iwry, deputy assistant secretary for retirement and health policy at the Department of the Treasury, wrote in an e-mail, “there’s plenty more that we can do, and there’s a lot more that the private sector can do.” Earlier this year, the department changed its rules to encourage people to purchase longevity annuities—which don’t start paying out until age 80 or 85—with money from 401(k) accounts and individual retirement accounts. “As boomers approach retirement and life expectancies increase, longevity-income annuities can be an important option to help Americans plan for retirement and ensure they have a regular stream of income for as long as they live,” Iwry said.

The lack of preparation for post-retirement spending means a lot of people are going to find they don’t have enough to live on, says Janice Scherwitz, a benefits specialist at a hospice in Florida. “They are probably going to have to end up being in the workforce a lot longer than they would like,” she says. “We have a whole new group of people who don’t even have a clue of what they need to live on and are going to come to a terrible realization someday.”