Baby boomers have been reaching retirement age at a rate of 10,000 per day since 2011, as reported by The Pew Research Center. The National Center for Health Statistics reports life expectancy is steadily increasing. Longevity, as measured from age 65, is now 83 for men and 85.5 for women. The Society of Actuaries estimates upper-middle-class couples age 65 today have a 43% chance that one or both will survive to at least age 95. If life expectancies continue to increase at the current pace, the chance of that 65-year-old reaching 95 climbs to 50% in 15 years. This means retirement funds need to last 30 years for those planning to retire at age 65.
The debate over the 4% prudent withdrawal rate continues to address one of the biggest concerns of people entering retirement – Will I run out of money? Ever since William Bengen1 developed the rule more than 20 years ago, more studies have followed that show the rule either doesn’t work or that 4% is the wrong number. Mr. Bengen was quoted as saying the actual number was closer to 4 ½% in a 1997 interview with Journal of Financial Planning2. He did a follow up review of the rule in 20123 for Financial Advisor magazine where he concluded that the rule appeared to be working. Some of the thinking from both sides of the debate includes:
The studies determined success or failure by whether a portfolio had any money left at the end of life expectancy. The original research used a portfolio of 50% equities and 50% bonds to determine success. Critics argue that portfolios with higher allocations to equities could support higher withdrawal rates. Some research shows a withdrawal rate of 5.8% to 6.2% is sustainable depending on the allocation to equities. A 2004 study4 found a 68% success rate over a 30-year retirement using a 6% withdrawal rate for a portfolio of 75% equities and 25% bonds.
Some retirement planners believe success should include the client’s life goal of an ending estate value. Certainly, smaller withdrawal rates will leave more money in the estate, but how much is too much? They believe few clients would consider the rates successful if they die leaving a large estate because they minimized their spending at the start of retirement.
Another argument takes into consideration the amount of guaranteed income the client has outside of their investments. Retirees with sizeable pensions and those who are receiving the maximum Social Security benefit could take larger withdrawal rates. Their risk is minimized by the guaranteed income they have to fall back on should their portfolio decline too quickly.
Other studies believe the 4% rule is too aggressive because it uses historic returns to determine success or failure. A 2012 study5 looked at the recent equity market returns compared to those of the 20th century. The study questions whether we should rely on future returns matching those of the past. Pointing to the disparity of returns of the international markets compared to domestic equity returns, the suggestion is that our equity markets may look more like the global markets, rather than global markets following the United States.
Current market conditions compared to the historic returns used in William Bengen’s research is a theme of those who believe the 4% withdrawal rule is too aggressive. Besides equity values, low interest rates are another reason to take smaller withdrawal amounts. A 20136 study looked at the impact of low interest rates on the 50% bond allocation. The current 10-year treasury yield is under 2%, which is about half of its historic average. This study suggested the failure rate could rise to 57% using a 4% withdrawal.
What This All Means
Obviously, no one knows what future investment returns will be. One of the keys to success in retirement is to remain vigilant of your withdrawals in down markets and be disciplined in your spending when needed. Don’t blindly follow a withdrawal rule without using common sense. We put a ceiling on withdrawal rates to protect our clients in bad markets. Our ceiling is 6%. Start withdrawal amounts at 4% of the portfolio value and monitor the rate in down markets. It’s time to cut back when the rate exceeds 6%. Another safeguard is to put off big discretionary expenditures until good markets return. Finally, stick to your investment strategy and don’t let current investment fads lead you astray.
- A healthy 65-year old couple has a 43% chance of one of them living to age 95.
- Inflation will nearly triple the cost of goods and services over 30 years.
- Retirees will need a growing source of income in order to fight 30 years of inflation.