by Archie M. Richards, Jr., CFP^®
February 19, 2001

If you're willing to exhaust your capital during retirement, the monthly withdrawals may be bigger than you think.

Ed wrote that he has a thrift savings plan which offers various index funds. In last week's column, I recommended funds that track as many of the world's stocks as possible, half U.S. and half foreign. (Of the world's total stock values, over half are foreign. Where the risks are higher, the prices in relation to earnings are likely to be lower.)

Ed implied that he and his wife are starting retirement. "We will draw out money in small, equal monthly payments," he wrote. "Our time horizon is 8-to-10 years." I surmise that Ed is willing for the funds to be exhausted. With medicine performing miracles these days, ten years seem too short for exhausting capital. I'll assume instead that the funds are to last for twenty years.

Some people would say, "Exhaust capital? What a sacrilege! A person can draw out income, but the capital should be left alone."

Yes, sure, that's easy to say if you're rich. But if you're not, the capital might have to go. It is not your purpose to care for your capital. It is the purpose of the capital to care for you. If the money must be spent, so be it. If the children resent being left out, that's too bad. You love them, and you tell them so, but if you need the money for reasonable living expenses, they'll have to make it on their own.

Ed didn't say how much his thrift savings plan holds, but I'll assume $100,000. With the money invested in unmanaged mutual funds broadly covering stocks of the world, I also assume that the funds will grow at the rate of 10 percent a year. In truth, I expect the value of the world's stocks to grow by at least 12 percent a year during the next twenty years, but we'll assume 10 percent. Some years will be winners, others losers. During the down years, the stock funds must not be sold.

Okay, we've got $100,000 growing at 10 percent. Not taking into account income taxes, how much can be withdrawn every month so that the funds will be exhausted in twenty years?

The answer is $965 a month. That's $11,580 a year, a hefty amount, considering we're talking only $100,000 with a period as long as twenty years.

Let's see, in the first year the $100,000 account gains $10,000. You withdraw $11,580, leaving $98,420. In the second year, the funds gain $9,842. You again withdraw $11,580, leaving $96,682. And so on. (Since the actual compounding would be monthly, these numbers are off, but you get the idea.)

You can figure this yourself. A financial calculator costs a lot less than a financial planner. Enter minus 100,000 as the starting value. (It's minus because you're "paying out" $100,000 into your hypothetical program.) Enter zero as the ending value (the funds will then be used up). Enter 240 as the number of periods (the number of months in twenty years). Enter .83333 as the interest rate (10% divided by 12 months in the year). Press the "payment" button. Presto! The answer is $965.02. (When all else fails, read the directions.)

Foreign stocks and domestic stocks won't fluctuate at the same rates. Therefore, adjust the payouts each year to make the two sides as equal as possible. Alternatively, sell whichever portion that's gotten too large each year and buy the smaller portion. For long-term gains, wait at least a year and a day after the previous switch. Do not switch, however, if more than a tiny charge is incurred. Neither should you switch if the sale creates a tax problem. Just let the imbalance ride.

If you can reasonably get by on $865 a month instead of $965, I would choose the lower amount. This provides a little extra in a pinch. But even $865 would beat the monthly amounts you'd receive from an immediate, joint-life annuity.

When your money is in stocks and you're willing to exhaust capital, the monthly income can be surprisingly large. If nothing major occurs, we'll talk next week about immediate annuities.