There’s a common retirement rule of thumb that you should withdraw 4% of your savings annually to make it last for 25 to 30 years.
As paltry as a 4% annual drawdown sounds, with inflation running at 40-year highs, that may be too much, experts say.
It also doesn’t take into account what damage market volatility might do to a retiree’s portfolio with any meaningful amount invested in the markets. Let alone the possibility that one’s retirement years, especially with medical advances extending lifespans, could last well beyond 30 years.
Financial planners are now panning the 4% rule—and maybe retirees should, too.
“It’s not meant to be a retirement plan,” David Lau, CEO of DPL, tells Financial Planning magazine. “It’s meant to be a guideline for a portion of a retirement plan. Too many advisers and too many individuals self-managing their retirement are using this as the retirement plan.”
To assume that annual 4% withdrawals are safe, is an oversimplification, Lau says.
Consider how the 4% rule, first devised by financial planner William Bengen in 1994 in an academic paper based on historical returns dating back to 1926, works. Say you have $1 million in retirement savings. The 4% drawdown rule would instruct you to withdraw $40,000 a year.
In Bengen’s scenario, the investor would have a percentage of their savings in equities, which would permit their withdrawals to rise each year in tandem with inflation and last for 30 years.
In 1998, three professors at Trinity University in Texas confirmed Bengen’s theory, cementing the 4% drawdown rule.
Recently, Fidelity issued a study increasing that amount to 4.5%, and experts at a recent webinar hosted by DPL endorsed the 4% rule.
“Historically in the US, 4% has been that safe initial withdrawal rate,” said David Blanchett, head of retirement research at Prudential Financial investment advising arm, PGIM. “We can quibble with a lot of the assumptions of the analysis, but that’s not a bad starting place for most retirees.”
Blanchett nonetheless hedged those remarks, saying that the 4% should not be a blanket rule recommended by all retirement advisers.
Blanchett also recognized the pain investors have felt over the past year, saying, “It’s really difficult to put into words how awful this year has been. If a client walks into your office, you can’t just say, 4%!”
That is why Christine Benz, co-author of a Morningstar 2021 research report, amended that withdrawal rate to 3.3% due to expected lower market returns, The Wall Street Journal reports.
Recently, however, Benz and her co-authors ratcheted up that withdrawal rate to 3.8% for retirees with a 30-year horizon. She said Morningstar researchers had done so on how much stocks and bonds had been sold off and were poised for higher returns.
Morningstar’s updated thesis of a $1 million portfolio with 50% invested in stocks and 50% in bonds would permit a retiree to withdraw $38,000 in 2023. Should inflation moderate to 5% next year, the retiree could take out $39,900 in 2024.
Retirees who are optimistic about their lifespan and who are risk-averse may not want to withdraw 4%, 3.8% or even less, however.
Frank O’Connor, vice president of research at the Insured Retirement Institute, which is a proponent of annuities, lends a dose of skepticism to the 4% drawdown rule:
“The research work that led to the 4% rule is very specific in terms of the asset allocation,” O’Connor says. “It’s not a ‘whatever.’ So, you can’t create an ultra-conservative portfolio that’s only 20% allocated to equities and be aligned with that original research.”
The other critical factor to consider when weighing the 4% rule is inflation, which has historically run at 2% a year and was not a factor in the original research. Increasing your withdrawals every year to keep up with inflation, currently at 7.1%, could undermine the 4% rule’s very premise, O’Connor says.
“If your expectation is that you’re going to have to withdraw a lot more next year, and the year after, and the year after that—then you’d better start lower,” he says.
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