Accounts Often Empty as Retirement Begins

A recent study by Mercer Human Consulting found that the average 401(k) participant burns through his entire account in five years. Apparently far too many retirees withdraw unsustainable amounts in order to support their pre-retirement lifestyle.

Some of the commentary surrounding the release of the paper questions whether target-date funds should revise their glideslope to a zero equity position at retirement because no amount of asset allocation brilliance can compensate for a delusional self destructive withdrawal rate of 20% per year.

As background, long experience shows that withdrawals above 4% per year suffer dangerously high failure rates over the 30-plus-year expected retirement time frame. So, conventional wisdom in the financial planning profession balances retiree portfolios with a healthy dose of equities to maintain their long term buying power and a healthy dose of fixed income to meet their liquidity needs in the short run. For example, a retiree expecting a 4% withdrawal rate might be placed in a portfolio of 40% bonds, and 60% stocks.

However, that position is unacceptable if the account is destined to be liquidated in only a five year period. A more suitable asset allocation for such a short time horizon is probably close to 0% equities and 100% fixed income. The question posed by the paper’s author is whether the glideslope in target date plans should be adjusted to accommodate a five year drawdown or, said another way, should we have a zero equity exposure on retirement day?

That’s an interesting question, but misses the overarching issue: What is the retiree going to do for the following 25-30 years after his pension account is gone? If the average pension account lasts for only five years, then we have to wonder how the 401(k) system can ever meet our needs to provide a secure retirement for our citizens. If that’s the result, it’s a catastrophic failure for retirees.

Some very simple math demonstrates that if retirees select an annual withdrawal that depletes their account in five years, then for that amount to be sustainable their capital balance at retirement should be at least five times as great as they are. Unless you could argue that these retirees have huge balances in non-qualified accounts, or can sell their homes to each other at substantial profit, retirement for these people is likely to be a dismal experience. But there is precious little evidence to support either private savings or real estate profits.

The real question we should be asking ourselves is what are we going to do collectively to ensure that Americans will have enough capital accumulated to retire securely? Adjusting the glideslope for target date funds doesn’t come close to solving the fundamental problem.

Frank Armstrong III is founder and CEO of Investor Solutions, Inc., an independent, fee-only investment management firm in Coconut Grove, Florida. The firm has been named on Bloomberg’s list of Top Wealth Managers, rated a “Five Star” on the Paladin Registry, and selected by Barron’s as one of the top “100 Best” Independent Financial Advisors in the country. Frank has more than 35 years experience in the securities and financial services industry. He contributes to major publications and appears regularly on television and radio. He is author of the recently released book Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown. His previous books include The Retirement Challenge and The Informed Investor.