Live Long and Prosper

Q: How to manage 401(k) assets and other retirement accounts such that you don't outlive your resources.

Most Americans retiring in the future will not have significant benefits, if any, from traditional pension plans. Such plans have a unique, powerful advantage - you'll get a monthly income for the rest of your life, no matter how long you live. No need to worry about running out of money before you die. So much for the lucky few. The rest of us should be obsessed with managing our financial resources - typically 401(k) balances - so that we don't outlive them. The following paragraphs summarize strategies that I discuss in detail in my book Live Long & Prosper! Invest in Your Happiness, Health and Wealth for Retirement and Beyond (John Wiley, 2005).

There is one overriding strategy and three tactics that apply to drawing down and investing any lump sum of money, whether it is in a 401(k) plan, 403(b) plan, 457 plan, traditional or Roth IRA, or just an account that has no special tax features.

Here is the overriding strategy:

Don't consider your lump sum as money you can spend in retirement. I know this sounds weird, but stay with me for awhile. My worry is that you might think you've got a lot of money, so you buy a new car, take lavish vacations, and before you know it, your resources have dwindled significantly. Instead, consider your lump sum as a generator of a monthly paycheck. Then, spend no more than this paycheck. We're used to living paycheck-to-paycheck while we're working, so let's not stop this healthy behavior when we retire. To calculate your monthly retirement paycheck, use one of the tactics described below which minimize the chance of ruin (outliving your money).

These three withdrawal and investing strategies are designed to last for life.

  1. Spend just the income from interest and dividends. This guarantees that you won't outlive your money. Interest and dividends aren't paid monthly, so you'll need to spread it appropriately. One easy way is to invest in a good balanced, lifestyle, or target allocation mutual fund; the asset allocation to stocks can range from 40% to 70%, with the rest in bonds or cash. Your income should be roughly 3% per year, give or take 50 basis points.
  2. Withdraw income and principal in a way that minimizes the likelihood of outliving principal. One safe rule of thumb is to calculate 4% of the balance at the beginning of each year; divide by 12 to determine your monthly withdrawal for the year. This still has a probability of outliving your resources, although the odds are very low. You can use Monte Carlo modeling to determine a higher withdrawal percentage with corresponding odds of ruin. For example, a 65 year old single man can withdraw 5% per year and have a 1:10 chance of ruin. My book has more details and charts on this strategy.
  3. Buy an immediate annuity from an insurance company. These are not to be confused with deferred annuities, which are investment vehicles that can have high expenses. With an immediate annuity, you give a lump sum of money to an insurance company, and they promise to pay a monthly income for life. It's a do-it-yourself pension. You can continue income to a spouse in case you die first. Pay attention to the safety rating of the insurance company - I prefer one of the four highest ratings from S&P or Moody's. You can now buy these online from insurance dealers who shop among a handful of insurance companies to get the best deal.

Other thoughts:

  • You don't need to exclusively use one tactic or the other. In fact, I wouldn't put all my money in an immediate annuity - I'd save some for reserves, and use one of the first two withdrawal strategies on the reserve balance.
  • I prefer using the first method - living on interest and dividends - in my 'early' retirement years, through my late sixties or early seventies. To supplement my investment income, I'd work part-time; there are other good reasons for doing this, such as remaining engaged with life and possibly getting employer-sponsored health insurance. I'd wait until my mid seventies to buy an annuity - consider it longevity insurance. It has another great feature - I don't need to manage my money. This might help when I'm not as sharp as I used to be.

As you can see, this isn't a 'one size fits all' exercise. It's part art, part science. It takes patience, skill, and understanding of the issues. It's well worth your time to learn about all the tactics and figure out which combination works best for you. Good luck!

Steve Vernon

Q: Does money buy happiness? Spend just enough to meet your needs and be truly satisfied with life.

Here are the opening lines from the chapter in Live Long & Prosper titled 'What Do We Really Want?:

Most of us really want to live the rest of our lives with meaning, purpose, happiness and health. We want things to go well for our loved ones, ourselves, and the world. We want to realize our full potential as human beings. This is the way I think, and I suspect I have lots of company.

How much money do we need for this? Can we use this as a guideline for determining what to buy?

There is a lot of recent research on what makes people happy. It turns out that for most people, it's not money. People who are in poverty, who aren't meeting their basic human needs, they will increase their happiness if they get more money. But once you have enough money to meet your basic human needs, however defined, adding more money doesn't add much to happiness.

Economists have an elaborate theory on this, called utility theory. This theory contends that there is not a direct relationship between satisfaction with a purchase and the amount of money spent. As you spend more money on a given item, your satisfaction does not increase proportionately, and after a certain point, your satisfaction barely increases.

Here's a real life example of this. According to the JD Powers survey on customer satisfaction with car purchases, the reported overall satisfaction with a Honda is X.X. The reported customer satisfaction with a Mercedes Benz is Y.Y, an x.x% increase. However, we all know that the Mercedes costs two to three times as much as the Honda.

This leads me to a strategy for all my purchases, whether a house, car, furniture, or anything else that costs a lot of money. It's called just enough. What is just enough to meet my needs and make me happy? I'm not advocating that we spend nothing, living a miserly life. I'm talking about spending just enough!

Martin Seligman examines the research on positive psychology in his book Authentic Happiness, and he makes the following definitions:

  • The pleasurable life comes from those good feelings when you go out on the town, have a nice vacation, buy a new car, etc.
  • The good life is when you apply your skills, interests and values to your immediate surroundings - yourself, your family, and your friends.
  • The meaningful life is when you apply these same skills, interests and values for the greater good, to something beyond yourself - your community, your country, the earth, humankind.

People who are really satisfied with life have a healthy balance between all three.

I think Americans are caught in a trap with respect to the pleasurable life. We work very hard - harder than all of the industrialized nations, according to the average hours worked per week. So we deserve that new car, the bigger house, the exciting vacation. And the commercials tell us that we will be happy if we spend our money on their products. And we listen, so we spend all of our money on the pleasurable life, with little time, attention or money spent on the good life or the meaningful life. There aren't many commercials advocating that we spend money on these things. Why? Because there isn't much money to be spent on the good life or the meaningful life!

So I advocate that we stop letting commercials tell us what to buy and how to spend our time. Stop letting someone else tell us how we should live. Instead, let's focus on what truly makes us happy. Usually that means some combination of having good relationships with friends and family, continued growth and learning, doing our life's work (however defined), and appreciation for beauty in the world.

Let's buy just enough for that.

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