Protect your nest egg, or risk running out of money

I saw a guy run out of chickens recently. As always, it was a horrendous sight.

Like most people, he worked a long career and stored up money for his retirement years. His life savings was meant to last until his last breath. But it didn’t.

The eggs of retirement income laid by the chickens — his assets — weren’t enough to satiate his appetite. Thus, he began to eat the chickens. And before he knew it, fewer chickens were producing fewer eggs. In order to survive, he was forced to send feathers flying again. Just like that, there were no more eggs and no more chickens.

His retirement was ruined.

I don’t fear much financially, but I do fear running out of chickens. It’s a fairly complicated problem, with more moving pieces than a Swiss watch. Retirement lifestyle, health care expenses, rate of return and inflation are just the beginning of what becomes an incredibly difficult math problem. And as a colleague recently succinctly pointed out, the biggest unknown is what makes the other unknowns so vital.

“The fundamental problem of financial planning is, we don’t know exactly when we’re going to die,” he offered during a recent team meeting. “Otherwise, it’s a relatively simple math problem.”

The math he was referring to was decumulation math.

A decumulation strategy is a fancy way of saying retirement-income strategy. You’re trying to determine how much money your retirement nest egg can safely provide you on a monthly basis. If you knew for certain your retirement was 10 years long and lacked any unusual, major expenses, you’d simply divide your assets by 120 (accounting for inflation, of course), and enjoy your remaining years without financial stress.

You can immediately see the problem, can’t you?

Retirement, like the rest of life, is rarely defined by what we know is going to happen. Instead, it’s defined by what we don’t know is going to happen. The unknown is what makes it more likely we’ll run out of money.

Running out of money in retirement isn’t a small problem. It’s the worst problem. It’s a problem so bad that Plan B, C, D, and whatever comes after those are the things nightmares are made of. Distilled down to its essence, my general response to the average person’s lack of retirement preparation isn’t rooted in anger or judgment. Instead, I mourn for their loss of a normal financial existence, as their final chicken roasts instead of roosts.

Accumulating money is relatively easy. I can’t believe I just typed that. But it’s true. Just regularly save and invest money throughout your career, and when you’re ready to retire, you’re forced to make decisions based on how much or how little you accumulated. There’ll be bumps, mistakes, disasters and plenty of come-to-Jesus moments. But in the end, you’ll have what you’ll have, and you’ll have to put a plan together to decumulate it.

For years, the bulk of the financial-advising community agreed that 4% was the magic number. You could, with a degree of confidence, withdraw 4% of your retirement nest egg in any given year. Therefore, a $1 million portfolio would create $40,000 in retirement income in its first year. And if by the grace of the markets, your account value swelled to $1.1 million by the beginning of year two, you could take $44,000 of income.

While the “4% rule” has met resistance in the last several years, at least it was a framework for what decumulation should look like. And for me, it follows the chickens-and-eggs theory that I find to be a helpful visual.

Anecdotally, rarely have I seen a person stick to 4% or less in the first few years of retirement, especially if the person is healthy and active. And once that egg-hungry lifestyle is established, it’s difficult to decelerate the retiree’s appetite.

I haven’t even gotten to the scariest part — sequence-of-returns risk. The market ebbs and flows. You’re likely comfortable with this dynamic. But if the market ebbs at the wrong time, such as right when you retire, it’s as though you left the gate open and five chickens ran away before putting in any work.

Decumulation is made exponentially more difficult when you do it during a down market, which you will likely do at some point. A good financial adviser not only will account for this reality during your initial decumulation planning sessions, but on the fly when it’s actually happening.

I hope you like eggs — but not too much.•

Peter Dunn is CEO of Your Money Line powered by Pete the Planner, an employee-benefit organization focused on solving employees’ financial challenges. Email your financial questions to askpete@petetheplanner.com. Opinions expressed are those of the author.