Taking Care of Mom and Dad: Pulling Money Out As They Need It
When it comes to converting investments into spendable cash, one way is simply to pull the money out as needed. This means that your parents live on interest and dividends from fixed-income investments or that they withdraw a certain percentage of their portfolio's value each year and adjust that amount for inflation to maintain purchasing power.
This method allows them to maintain complete control of their assets. If they get hit with sudden expenses, they can boost their withdrawals to meet those expenses. They decide which stocks or fund shares to buy or sell and can work tax laws to their advantage.
The "as you need it" approach does have some setbacks. First, it requires regular attention and management. Some people don't want to do that. Your parents could invest badly and lose their money. If neither you nor they are good about how to estimate the length of draws on assets before running out, they might find themselves in a jam when they're still kicking but are out of money.
Don't assume that, if life expectancy charts say that your mom is 65 now and she's expected to live to 85, you should only plan for her living that long. She might live to 95. Or 105!
A life expectancy of 85 means that roughly 50 percent of the 65year-olds alive today will have died by age 86. The other 50 percent, however, will live beyond 86, in many cases well beyond. In fact, a 65-year-old woman today has about a 15 percent chance of making it to age 95 and a 4 percent chance of living to 100.
The second problem with the withdrawal system is the tendency to be too optimistic about their money. The markets can be sketchy; anything can happen to change the ball game and make for a very stressful life. Based on average annual returns of about 15 percent for stocks and 10 percent for bonds during the 1980s and 1990s, you might think that an inflation-adjusted withdrawal rate of 10 percent is reasonable. Many people do. But those recent averages are well above historic norms and they become irrelevant during a market downturn like the one that started in 2000, where many stocks lost 30 percent or more of their value.
If something happens in the market that trims your parents' portfolio down considerably, they won't be able to maintain their usual withdrawals over the long haul.
Example: Someone retiring at the beginning of the 1973 to 1974 bear market with a portfolio invested 60 percent in stocks and 40 percent in bonds would have run out of money in less than eight years with a 10 percent withdrawal rate. Even a change in the withdrawals to a rate of 5 percent would have kept the portfolio going only another 13 years.
Financial planners often suggest that retirees need between two-thirds and three-quarters of their pre-retirement income to maintain their standard of living. That's based on the assumption that spending in retirement declines as expenses such as commuting, business clothing and coffee breaks disappear.
Your parents can reduce the chances of their portfolio running dry by starting with a lower withdrawal rate or by reducing their withdrawals during market setbacks. They can also think about changing the mix of their portfolio, weighting it with some stocks to decrease -- though not eliminate -- their odds of running dry. But unless they choose a withdrawal rate in the neighborhood of 3 to 4 percent or they are fortunate enough to be retired during a time when the financial markets rack up impressive returns, they face a small but significant risk that their money will run down before they die.
