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Retirement Planning

Rethinking the Retirement Withdrawal Rate

Why the “4% Rule” May No Longer Apply

How many calories can you consume daily and still lose weight? What’s the optimal amount of exercise needed to lower your blood pressure?

We all seek rules of thumb to help us achieve our goals. When it comes to retirement withdrawals, few guidelines have been more popular than the “4% rule”.

Back in the early 1990s, a little-known financial planner named William Bengen set out to determine how much retirees could safely withdraw annually from their nest eggs.

After testing a number of retirement withdrawal rates over a period of 50 years, Bengen arrived at an answer: A retiree with an investment portfolio split between large-cap stocks and intermediate-term U.S. bonds could withdraw 4% a year from an original account balance, adjust that amount annually for inflation — and still have money left after 30 years.

That means if you have retirement savings of $1 million, you would withdraw about $40,000 a year, adjusted yearly for inflation, regardless of how your investments are performing.

Over the years, Bengen’s retirement withdrawal rate became a cornerstone of retirement planning. “It’s like eating four vegetables a day,” said Michael Herndon, vice president for financial resilience at AARP.

But lately, critics have questioned the 4% rule. Some say it might be too aggressive for today’s retirees, given current market conditions and longevity risks.

Is the 4% rule the appropriate retirement withdrawal rate for today’s retirees?

What Are the Origins of the 4% Rule?

Before Bengen came along, financial planners often looked to historic average annual returns as the basis for determining safe retirement withdrawal rates for their clients.

But those assumptions didn’t take into account market volatility and sequence of return risk — the risk that retirees face if they experience weak returns early on in their retirement.

Bengen, who trained as an aerospace engineer at the Massachusetts Institute of Technology, decided to dig deeper. He looked at every 30-year period from 1926 to 1976 and found that even under the worst-case scenario, a retiree could still withdraw about 4% annually and not run out of money after 30 years.

Why Are Critics Questioning the 4% Rule?

The rule is based on assumptions that may no longer apply.

Wade Pfau, a professor of retirement income at the American College for Financial Services and a key critic of the 4% rule, notes that as people live longer, there’s a higher likelihood they might need their retirement nest egg to stretch beyond 30 years.

In addition, today’s market conditions — a combination of low bond yields and high stock market valuations — make the idea of withdrawing 4% a year from a retirement portfolio a riskier retirement withdrawal strategy.

“U.S. interest rates are at historic lows, we’re in uncharted waters,” Pfau said. “3 percent is a safer [withdrawal rate] in a low interest world.”

But while Pfau sees 4% as too risky, others worry that retirees might shortchange their retirement by sticking to a strict withdrawal regimen. If market conditions are strong in the future, retirees could end up with extra savings they didn’t get to enjoy during their lifetime.

What Does It All Mean for You?

You might consider the 4% rule more as a benchmark and less as a hard-and-fast retirement withdrawal rate that must be followed year in and year out.

“The 4% rule is just the start,” said Jamie Hopkins, co-director of the New York Life Center for Retirement Income at the American College of Financial Services. “What you really need is comprehensive financial planning.”

As you think about an appropriate retirement withdrawal rate, first ask yourself whether you have other sources of income you can draw upon in retirement, such as a pension, an annuity or Social Security. If you do, a higher withdrawal rate from your retirement savings might be worth considering.

Consider hiring a financial advisor who can help you tailor an investment mix, as well as retirement withdrawal strategies that are appropriate for you given your personal situation and tolerance for risk.

Revisit your spending habits periodically and consider adjusting your behavior based on your portfolio’s performance. “Run the numbers,” advised Roger Wohlner, writer of the financial planning blog TheChicagoFinancialPlanner.com.

It’s important to keep in mind that retirement can be unpredictable, and rules of thumb, while helpful, can only go so far in guiding your unique financial situation. Whether or not you follow the 4% rule, it’s valuable to have a plan in place and to revisit that plan frequently to make sure you’re on track. Striving for peace of mind in retirement is a goal that’s worth your effort.


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