Twenty years ago, a financial advisor named William Bengen identified a disturbing trend. Retirees, who used to be able to count on Social Security and pensions, were starting to depend upon their own savings to manage retirement.
This problem is even more acute today, as companies have largely abandoned pensions in favor of 401(k) programs. With retirees forced to be more self-reliant, they began asking a new question:“How much can we safely withdraw from our portfolio each year during retirement and not run out of money?”
Tough question! Mr. Bengen developed a solution in 1994 and published his research in the Journal of Financial Planning. Today his approach is called “the rule of 4%,” although Mr. Bengen would actually call it the “rule of 4.5%.”
After reconstructing the investment experience of retirees over decades past, Mr. Bengen concluded that if retirees withdrew no more than 4.5% of the portfolio in the first year and then adjusted annually for inflation, they could be confident they wouldn’t run out of money over a 30-year retirement. The number was depressingly low for many, but nonetheless, the majority of financial advisors began to recommend it.
Today, however, Mr. Bengen acknowledges “we’re in a period of time which may challenge it.” After two massive drops in the market since 2000, many retirees have been forced to either go back to work, cut back on expenses, or pursue options like reverse mortgages.
Frankly, it’s time for new research. Princeton Ph.D., Wade D. Pfau, Ph.D., has tackled the question again in his paper, “Can We Predict the Sustainable Withdrawal Rate for New Retirees?” published in the Journal of Financial Planning. In his study, Dr. Pfau predicts that for a portfolio invested 60% in stocks, the safe withdrawal rate is 1.8%.
If 4% was tough to swallow, how easy is it to imagine only withdrawing 1.8%? To put this in perspective, this means if you worked hard enough to save $1,000,000 for retirement, you can expect to live high on the hog with $18,000 per year. Frankly, this is getting ridiculous.
Apparently, Money Magazine thinks so, too. In an article entitled, “Forget the 4% Withdrawal Rule,” Money Magazine listed 3% as a safe withdrawal rate. They also said, at 3% you still have a 24% chance of outliving your savings. Do you want to go into retirement with a 24% chance of running out of money before you run out of life?
In truth, you don’t have to live a low-income, low-expectation retirement, if you’re willing to take advantage of the innovation that has occurred in financial products over the last several years.Today, retirees using safe, principal-protected vehicles can actually have guaranteed withdrawal rates of 5, 6 or even 7%.
If you want to insure your standard of living during retirement, give us a call and let’s have a conversation.