After leaving Caterpillar, it can be difficult to save for retirement, and it can be equally challenging to use those savings prudently. How much can you withdraw annually from your savings? This is an important issue that many of our Caterpillar clients frequently ask, and with good reason: if you withdraw too much, you risk running out of money, but if you withdraw too little, you may lose out on a comfortable Caterpillar retirement.
The '4% rule' has been the most prevalent guideline for over 25 years. This rule suggests that a withdrawal equal to 4% of the portfolio's initial value, with annual adjustments for inflation, is sustainable over a 30-year retirement period. This guideline can assist Caterpillar employees in establishing a savings objective and providing a realistic picture of the annual income their savings could generate. For example, a $1 million portfolio could generate $40,000 in the first year, followed by inflation-adjusted withdrawals.
Over the years, the 4% rule has generated substantial debate, with some experts contending that 4% is too low and others arguing that it is too high. Due to the allegations, we believe it is necessary to analyze both the original and most recent research regarding the 4% rule with our Caterpillar customers. The rule's creator, financial expert William Bengen, believes it has been misconstrued and provides new insights based on recent research. Determine whether he is right.
Original research
Bengen published his findings for the first time in 1994, after analyzing data for retirements from 1926 to 1976 — a total of 50 years of data. He considered a hypothetical conservative portfolio consisting of fifty percent large-cap equities and fifty percent intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. In the worst-case scenario, retirement in October 1968, a 4% inflation-adjusted withdrawal rate was the greatest sustainable rate. This marked the onset of a prolonged bear market and high inflation. All other retirement years featured higher sustainable rates, with some exceeding 10%.[1]
Obviously, no one can predict the future, which is why Bengen proposed a sustainable rate based on the worst-case scenario. Based on a more diversified portfolio of 30% large-cap equities, 20% small-cap stocks, and 50% intermediate-term Treasuries, he later increased it to 4.5%.[2]
New research
Now that we comprehend Bengen's original research, we'd like to examine a more recent analysis conducted with Caterpillar clients. Bengen published new research in October 2020 that attempts to project a sustainable withdrawal rate based on the valuation of the stock market and inflation (the annual change in the Consumer Price Index) at the time of retirement. Theoretically, when the market is expensive, it has less potential for growth, and it may be more difficult to sustain increased withdrawals over time. Lower inflation, on the other hand, results in lower inflation-adjusted withdrawals, allowing for a higher initial rate. A first-year withdrawal of $40,000 becomes $84,000 after 20 years with a 4% annual inflation increase, but only $58,000 with a 2% increase.
Bengen used Shiller CAPE, the cyclically adjusted price-earnings ratio for the S&P 500 index devised by Nobel laureate Robert Shiller, to measure market valuation. The price-earnings (P/E) ratio of a stock is the share price divided by the stock's 12-month earnings per share. For instance, if the price per share of a stock is $100 and its earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE is calculated by dividing the total share price of S&P 500 equities by their 10-year average inflation-adjusted earnings.
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5% Rule?
Bengen utilized historical data once more, this time for over sixty years of retirement. Bengen discovered a correlation between market valuation and inflation at the time of retirement and the utmost sustainable withdrawal rate by analyzing retirement dates from 1926 to 1990. Historically, rates ranged from as low as 4.5 percent to as high as 13 percent, but the scenarios that supported high rates were rare, involving extremely low market valuations and/or deflation rather than inflation.[3]
Since the Great Recession, the United States has experienced low inflation and high market valuations for the majority of the last 25 years.[4-5] Bengen found that a 5% initial withdrawal rate was sustainable for 30 years in a high-valuation, low-inflation scenario at the time of retirement.[6] While this is not a substantial deviation from the 4% rule, it does suggest that retirees could make larger initial withdrawals, particularly in an environment with low inflation. However, when inflation is significant, withdrawals should decrease.
A caveat is that the market's current valuation is extremely high: At the end of 2020, the S&P 500 index had a CAPE of 34.19, a level only attained (and surpassed) during the late-1990s dot-com boom and higher than any of Bengen's research scenarios.[7] His range for a 5% withdrawal rate is a CAPE of at least 23 and an inflation rate between 0% and 2.5%.[8] (Inflation in November 2020 was 1.2%.)[9] Bengen's research suggests that a 6% withdrawal rate may be sustainable if inflation is 5% or less and market valuation falls to near the historical mean of 16.77. Alternatively, if valuation remains high and inflation exceeds 2.5%, the utmost sustainable rate could reach 4.5%.[10]
Caterpillar employees must remember that these projections are based on historical scenarios and a notional portfolio, and there is no assurance that their portfolio will perform similarly. Caterpillar employees must also keep in mind that these calculations are based on annual withdrawals adjusted for inflation, and you may choose not to increase withdrawals in certain years or use other criteria, such as market performance, to make adjustments.
Although there is no guarantee that working with a financial professional will improve investment performance, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, such as your withdrawal strategy.
We would like to remind our Caterpillar clients that all investments are subject to market volatility, risk, and principal loss. Investments may sell for more or less than their initial cost upon sale. The timely payment of principal and interest on U.S. Treasury securities is guaranteed by the federal government. Treasury securities' principal value fluctuates with market conditions. They may be worth more or less than the amount paid if not held to maturity. Allocation of assets and diversification are techniques used to manage investment risk; they do not guarantee a profit or guard against investment loss. Rebalancing requires the sale of some investments in order to purchase others; the sale of investments in a taxable account may result in a tax liability.
The S&P 500 index is an unmanaged collection of stocks that is representative of the U.S. stock market as a whole. The performance of an unmanaged index is not indicative of any particular investment's performance. Individuals cannot invest in an index directly. Past performance is not indicative of future performance. The actual outcomes will differ.
Conclusion
Imagine you are on a road trip, driving through unfamiliar terrain. You come across a fork in the road, with one path leading towards a beautiful and scenic destination, while the other path looks rocky and uncertain. The decision you make at this juncture could have a significant impact on your journey and your ultimate destination. Similarly, retirement is like a fork in the road of life. One path leads to a comfortable and enjoyable retirement, while the other path could lead to financial difficulties and hardship. This article provides guidance on how to navigate this fork in the road, with tips on how to save and invest wisely, how to plan for unexpected events, and how to ensure a comfortable retirement. Whether you are a Caterpillar worker looking to retire or an already existing retiree, the information in this article is pertinent to you and will help you make the best decision for your retirement journey.
1-2) Forbes Advisor, October 12, 2020
3-4, 6, 8, 10) Financial Advisor, October 2020
5, 9) U.S. Bureau of Labor Statistics, 2020
7) multpl.com, December 31, 2020
How does the transition from the Solar Plan to the Caterpillar Inc. Retirement Income Plan impact current or former employees of Caterpillar Inc. in terms of retirement benefits and service credits? Considering both plans' differences, what aspects should employees of Caterpillar Inc. understand to ensure they are maximizing their retirement benefits under this merged structure?
Transition from Solar Plan to Caterpillar Inc. Retirement Income Plan: The transition from the Solar Plan to the Caterpillar Inc. Retirement Income Plan maintained the benefits of those previously covered under the Solar Plan without impact. Both plans allowed the continuation of prior service credits and the incorporation of benefits payable under previous retirement plans. For current or former employees, understanding the nuances of how prior service credits and benefits are integrated can maximize their retirement benefits under the merged structure.
What specific criteria must Caterpillar Inc. employees meet to qualify for early retirement and what implications does this have on their pension benefits? For employees planning early retirement, what calculations or benefit reductions should they be prepared for according to Caterpillar Inc.’s policies?
Criteria for Early Retirement at Caterpillar Inc.: Employees wishing to take early retirement must meet specific age and service requirements detailed in the plan documents. For early retirement, benefits calculations and potential reductions are significant. Employees need to prepare for possible reductions in their pension benefits depending on their age and years of credited service at retirement.
In the context of the Pension Equity Plan (PEP) and the Traditional Pension Plan, how do the benefit calculations differ for employees at Caterpillar Inc., particularly for those who switched from the Traditional Plan to the PEP? What considerations should current Caterpillar Inc. employees take into account when evaluating which plan may offer them more secure benefits?
Differences Between PEP and Traditional Pension Plan: The benefit calculations for the Pension Equity Plan (PEP) and the Traditional Pension Plan differ significantly. PEP calculates a lump sum based on salary and years of service, while the Traditional Plan calculates benefits based on final earnings or credited service formulas. Employees need to consider which plan offers more secure benefits based on their individual career trajectory and earnings history.
What steps must Caterpillar Inc. employees take to ensure that their Credited Service is accurately calculated and maintained throughout their employment, especially in light of the company's policies regarding breaks in service? How might phases of employment, such as parental leave or temporary positions, affect this calculation?
Credited Service Calculation and Maintenance: To ensure accurate credited service calculation, employees must maintain thorough records and communicate any changes in employment status, such as breaks in service or changes in personal information, to the plan administrator. Understanding the rules for service credits during different phases of employment, such as parental leave or temporary positions, is crucial.
How can employees at Caterpillar Inc. file a claim for benefits under the retirement plans, and what are the essential details they need to provide to ensure their claims are processed smoothly? If they encounter issues or denials, what recourse do they have within the Caterpillar Inc. system to appeal these decisions?
Filing a Claim for Benefits: Employees should provide detailed and accurate information when filing a claim for benefits under the retirement plans. If issues or denials occur, they have the right to appeal these decisions. Familiarity with the claims procedure and required documentation can streamline this process.
For employees approaching retirement, what resources are available through Caterpillar Inc. to help them navigate the complexities of their retirement benefits? What steps should an employee take if they wish to understand their benefits better or need assistance with retirement planning?
Resources for Navigating Retirement Benefits: Caterpillar Inc. offers resources to assist employees in navigating the complexities of their retirement benefits. Employees approaching retirement should utilize these resources and may need to engage with the company's human resources or benefits departments for personalized assistance.
What are the implications of the changes to the cash-out limit for de minimis benefits at Caterpillar Inc., which will take effect after December 31, 2023? How does this change affect employees who may have a vested interest in understanding their financial benefit options upon termination or retirement?
Implications of Cash-Out Limit Changes: The increase in the cash-out limit for de minimis benefits affects how small vested benefits are processed upon termination or retirement. Employees with small benefit amounts should understand how these changes may impact their options and tax implications.
How does Caterpillar Inc. ensure that its pension benefits are protected from creditors, and what specific provisions exist to safeguard these benefits? Moreover, how do legal instruments like Qualified Domestic Relations Orders (QDROs) interact with Caterpillar Inc.'s benefits system for employees undergoing divorce?
Protection of Pension Benefits from Creditors: Caterpillar Inc.'s retirement plans are designed with protections to safeguard benefits from creditors, including adherence to Qualified Domestic Relations Orders (QDROs) during instances like divorce. Employees should understand how these legal instruments can affect their retirement savings.
In what ways does the Caterpillar Inc. Retirement Income Plan provide coverage for disability retirement, and how is this benefit calculated for employees? What factors influence eligibility and how do employees initiate claims if they find themselves in need of these benefits?
Disability Retirement Coverage: The plan provides specific provisions for disability retirement, including how benefits are calculated and eligibility criteria. Employees should be aware of how disability affects their benefits and the process for initiating claims if needed.
How can Caterpillar Inc. employees contact the company to learn more about their retirement benefits, and what information should they have ready when making inquiries? Additionally, what specific departments at Caterpillar Inc. should employees reach out to for the most efficient assistance regarding their retirement plan questions?
Contacting the Company for Retirement Benefit Information: Employees can contact the Caterpillar Benefits Center for inquiries about their retirement benefits. Knowing the specific departments to contact for efficient assistance is crucial for addressing concerns and making informed decisions about retirement planning.
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