Retiring the 4% rule: What is a safe withdrawal rate in retirement?

Jul 11th, 2017 | By | Category: Commentary


By Jennifer Landon/Commentary

Jennifer Landon

Jennifer Landon

For decades, financial advisers touted the “4-percent rule,” a benchmark rate of withdrawal designed to insure you don’t outlive your retirement nest egg. In recent years, however, experts have begun to question this hard and fast rule, and many have cut the rate at which you can safely withdraw from your retirement accounts to 3.5 and even 2.8 percent. So, what has changed? Here are 5 reasons you might want to retire the 4-percent rule:

It’s out of date, pt. 1. The 4-percent rule was devised during the 1990s, when interest rates were significantly higher than they are today. If you’d had “safe” investments, such as bonds and annuities, during that time you would have received considerably more income and therefore could have withdrawn more. Today’s low-rate environment, though, has changed all that. In their 2013 academic paper, “The 4 Percent Rule Is Not Safe in a Low Yield World,” researchers Michael Finke, Wade Pfau, and David Blanchett determined that “the success of the 4-percent rule in the U.S. may be an historical anomaly.” In other words, the high interest rates of decades past may have been the exception rather than the rule. In any case, low interest rates seem to be sticking around for the foreseeable future, so the prudent thing to do is to factor them into your plan for withdrawal.
It’s out of date, pt. 2. The 4-percent rule was designed to make sure your nest egg had a good chance of lasting 30 years, given a variety of market scenarios. Why 30? Because three decades was considered to be a very long retirement indeed. For instance, actuarial statistics from that time indicate that in 1970, a 65-year-old man could expect to live another 13 years. By 2011, according to the Centers for Disease Control, that figure had grown to 18 years. Women’s lifespans likewise grew over that time period, and these days, it’s not inconceivable that you could spend longer than 30 years in retirement. The fact that Americans are living longer is cause for celebration, but it also means your withdrawal rate needs to be adjusted accordingly.
It assumes linear consumption. A 2015 study by PwC examined the problem of the “sequence of consumption” as it relates to the 4-percent rule. This study found that contrary to such drawdown models, which assume a steady rate of withdrawal, retirees commonly spend more during the early years of retirement. This could be because they don’t know how much they can safely withdraw or because they’re indulging in long-awaited splurges such as expensive travel. In any event, real life rarely follows this linear trajectory. And while spending dips toward the middle of retirement, it picks up again at the end, most likely due to healthcare-related expenses. This uneven spending pattern can spell disaster for retirees who withdraw too much in the early years, putting a dent in their nest eggs for which no bull market can compensate.
The 4-percent rule worked well for many years, but unless your portfolio, spending patterns, and life expectancy closely match those used in the model, you could be putting your retirement at risk. Don’t automatically accept a one-size-fits all rate. Instead, ask a financial advisor to tailor a withdrawal rate that fits your circumstances. As PwC study author Anand Rao notes, “the approach [to retirement withdrawal] has to be much more personalized.”

About Jennifer Landon, Southeast Idaho’s Financial Educator

Jennifer Landon, founder and president of Journey Financial Services, is an accomplished advisor, educator and presenter on financial topics. Landon has spent the last decade advising Idaho Falls residents on the wealth and retirement planning strategies needed to help them achieve peace of mind on their retirement journey. She is an Investment Advisor Representative and a licensed life and health insurance professional in the state of Idaho. Landon is a member of Ed Slott’s Master Elite IRA Advisor Group, the National Ethics Association (NEA) and the Better Business Bureau. For more information about Jennifer Landon and Journey Financial Services, please call (208) 552-9169 or visit Jennifer Landon is an Investment Advisor Representative with Allegis Investment Advisors LLC, an SEC Registered Investment Advisor. 591 Park Avenue ste.101 Idaho Falls, ID 83402.

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