TITLE

When Should Retirees Retrench? Later Than You Think

AUTHOR(S)
Pye, Gordon B.
PUB. DATE
September 2008
SOURCE
Journal of Financial Planning;Sep2008, Vol. 21 Issue 9, p50
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
Saving enough to sustain a given standard of living with a 4 percent annual withdrawal from investments is a good goal. Studies show that such a withdrawal has good sustainability. Many people, however, have to retire well before accumulating enough assets to maintain their pre-retirement standard of living at this sustainable 4 percent rate. Also, even some of those who reach this goal may later have large unexpected expenses.The question all of these retirees must answer is, when should they retrench in order to maximize their satisfaction over all of their retirement years? This paper develops a Retrenchment Rule to determine when retirees should reduce their standard of living and by how much. This rule depends on a discount rate. This rate discounts future investment withdrawals for each year in the future until the withdrawals are expected. The value of this discount rate depends on the willingness of retirees to accept current sacrifice for future benefit, and on the anticipated returns on the investment. This paper establishes that a reasonable value for this discount rate is at least 8 percent. The surprising finding of this paper is that much of the retrenchment should be deferred, rather than implemented right away. This deferment occurs until the future unfolds and indicates how much retrenchment is actually necessary. Initial retrenchment generally does not reduce the need for future retrenchment sufficiently to justify the cost of a lower standard of living earlier in retirement. Using the Retrenchment Rule with an 8 percent discount rate, retirees should withdraw significantly more than 4 percent to avoid painful retrenchment.
ACCESSION #
34262456

 

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