Let's take a portfolio worth $30 million. We'll assume a yearly spending rate of $900,000 or 3%. Now, let's make the annual investment return a nice round 10%, peg inflation at 5% and put taxes at 20% for long-term gains and 45% for ordinary income.
In this scenario, a family can spend $900,000 a year for about 23 years-and then the money runs out.
Boost inflation to 7% and taxes to 25% for long-term gains and 60% for ordinary income (all within this country's post-World War II experience) and the family has just 16 years to enjoy its money.
And, if many prognosticators are correct in seeing capital markets remaining volatile and underperforming historical norms for a good while, the picture could get even darker.
Imagine an unexpected drawdown on the $30 million portfolio of 30% in year one with the same inflation and tax assumptions as just above, and the family's lease on a $900,000-a-year lifestyle falls to between 12 and 16 years.
When spending comes under pressure, wealthy families are likely to react by cutting charitable donations, according to Jason Pride, director of investment strategy at Philadelphia-based wealth- and asset-management company Glenmede. "It's one of the easiest things to change," he said. "That's especially true in a scenario where taxes are going up, and families see that as a case of the government taking away its discretion over gifting."
But acceptable spending rates don't always come down to cold appraisals of tables and charts.
"Different people have different takes on it," said Pride. "It depends on the stage of life they're in and what they want for the next generation--sometimes they don't want to leave an estate. And we always look at [spending rates] in the context of a holistic wealth plan."
Copyright (c) 2010, Dow Jones. For more information about Dow Jones' services for advisors, please click here.