It’s always a good time to audit your retirement income strategy
Paul Fain, CFP®
Do you have enough money saved to retire? Are you financially independent from the need to earn a paycheck? This is some important math as the coronavirus pandemic has moved some workers into early retirement, voluntarily or involuntarily.
Stated another way, when you enter retirement, how much can you safely withdraw from your investment portfolio and not run out of money before you die? The rule of thumb has generally been “the 4% rule,” that you withdraw no more than 4% of your starting balance each year in retirement. Note: the 4% rule doesn’t guarantee you won’t run out of money, but it does help your portfolio withstand market downturns, by limiting how much is withdrawn.
Retired financial adviser William Bengen, whose 1994 study popularized the 4% rule, has continued to update his model and presently thinks that up to a 4.7% withdrawal rate may be sustainable. However, Dr. Wade Pfau, a Professor of Retirement Income with The American College of Financial Services, states that “low interest rates continue to plague retirement” and could drive the safe withdrawal rate to a lower number (3.3%).
As you can infer, there are many variables that will influence your personal safe withdrawal rate: inflation, investment returns, longevity, healthcare expenses, legacy goals, tax rates, etc.
Teresa Ghilarducci, the Schwartz Professor of Economics at the New School for Social Research, writes that “blindly sticking with 4% is dangerous. Most experts agree it’s no longer safe to just assume the same historic returns for stocks and bonds, so 3% or 3.5% withdrawal rates might be better.” She adds, “Future inflation, especially for out-of-pocket health-care costs, may also make the 4% withdrawal rate too high.” Bengen believes that newer versions of his study may be too conservative with their rate of return assumptions, based on long-term historical data, but he concedes that inflation risk is a concern.
What to do? Pfau encourages retirees to adhere to a retirement income strategy such as a “Total Return” strategy based on interest and dividends plus asset appreciation expectations; or a “Bucketing” strategy that protects approaching spending needs with specific allocations to cash and bonds to cover years of anticipated retirement income needs; or an “Essential vs. Discretionary” strategy (using a guaranteed income floor such as an annuity to cover the basics, and, investments to cover the rest).
What strategy resonates with a person? What are the trade-offs? How can you commit to a strategy but maintain some flexibility for the future? Modern ideas, such as a dynamic withdrawal strategy with spending guard rails, are excellent examples of flexible approaches to sustainable retirement income planning. Your annual withdrawal rate might vary from 3% to 6% depending on economic and market conditions, i.e., loosening or tightening your retirement spending belt based on real-time experiences.
I turn 60 in a few weeks so I am keen for a gut check on this aspect of financial planning. It is never too early or too late to conduct your own retirement plan audit! May your new year be safe and blessed.
This article was originally published in the Knox News Sentinel on January 21, 2022