This Might Be the Key to Sustainable Spending in Retirement, According to a PhD
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The “4% rule” has long guided retirement spending — but even its creator now says it falls short. A new strategy from Stefan Sharkansky, Ph.D. and founder of The Best Third, offered a safer, more flexible alternative.
Here’s how his strategy works.
What Is the ARVA Method?
Sharkansky recommends the Annually Recalculated Virtual Annuity (ARVA) method for spending in retirement. With this approach, your retirement portfolio should contain only two types of assets — a ladder of Treasury Inflation-Protected Securities (TIPS) and a low-cost stock market index fund.
How TIPS Provide Guaranteed Income
“With TIPS, the dollar amounts of semi-annual interest payments and the bond principal that is repaid to you at maturity are adjusted upwards with inflation,” Sharkansky said. “So, unlike ordinary bonds whose dollar values are fixed, TIPS preserve your purchasing power. They’re the safest investment in the marketplace.”
Retirees should own individual TIPS bonds in a “ladder.”
“That means you have bonds that mature each year in your retirement period, up to 30 years,” Sharkansky said. “Each year, the maturing bonds — along with interest payments from later maturing bonds — provide a guaranteed source of income.”
At current interest rates, a 30-year TIPS ladder will pay out 4.5% of the initial investment every year, adjusted for inflation.
“A TIPS ladder today, all by itself, is better than the 4% rule,” Sharkansky said.
Creating a Retirement Salary and Bonus
Combining a TIPS ladder with a stock fund creates what Sharkansky calls a “salary plus bonus” retirement income.
“Many people in their working years are used to getting a base salary that they can count on, plus a bonus that can be a large part of their total income, but can vary from year to year,” he said. “With ARVA, the secure base ‘salary’ consists of Social Security, any pension you might have, other income like rental income, plus the guaranteed income from the TIPS ladder.”
You should invest enough in the TIPS ladder to reach the level of secure “salary” that you need to feel comfortable. Any extra funds should be invested in the stock index fund.
“This will provide you with your ‘bonus’ income, which will vary with stock market performance,” Sharkansky said. “When markets are up, you will get a larger bonus than when markets are down. But every year you will get a bonus.”
In an average year, the pay-out rate from your stock fund will be higher than the pay-out rate from the TIPS ladder, but in some years it will be lower.
“To smooth out the ups and downs, you hold both the TIPS for guaranteed, but probably lower income, along with stocks for probably higher, but variable income,” Sharkansky said.
Why ARVA Beats the 4% Rule
Sharkansky sees three main problems with the 4% rule:
- The 4% withdrawal rate is not actually “safe.” “The actual market returns that a person faces in retirement don’t necessarily follow the assumptions of a simulation. If the sequence of market returns in your retirement is at the lowest end of what the simulation thought was possible, you will either run out of money in retirement, or you’ll have to take sharp reductions in your spending.”
- On the flip side, you could end up spending less than you can actually afford. “In a very high percentage of scenarios, you will have money left over at the end of your plan. The most likely outcome with a 4% rate is that after saving for so many years, in retirement, you end up spending less than you can afford and not enjoying the standard of living and quality of life that you can afford.”
- Consistent withdrawals likely won’t match your actual needs, which can vary with time. “A retiree’s spending pattern changes as they age.”
“ARVA is a better alternative because it solves all three of the above-mentioned problems with constant withdrawal rates,” Sharkansky said. “It allows you to spend more while you’re alive, but without the risk of running out of money.”
ARVA allows you to take into account the anticipated changes to your spending needs and wants, as well as changes to your tax obligations.
“You can adjust your plan during retirement if your circumstances change,” Sharkansky said.
Sharkansky’s ARVA method offers retirees a way to spend confidently and flexibly. You can explore the strategy and build your own plan at TheBestThird.com.
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