A financial planning expert provides a compelling argument why the traditional rule for retirement withdrawals is far too conservative and should be ratcheted up from time to time where warranted.
A San Diego-based advisor named Bill Bengen created the 4% rule in 1993 after studying various 30-year retirement periods and calculating the annual percentage withdrawal rate that would ensure the savings lasted the entire three decades. Since 2008, many financial planners have suggested that 4% might be too high.
Financial planning expert Michael Kitces suggests that, despite the huge market correction in 2008, the withdrawal rate is still too conservative. A simple solution, says Kitces, is to ratchet up a client’s withdrawal limit by 10% whenever the value of their portfolio rises 50% from its starting value.
Most retirees, Kitces argues, have no reason to take out less because if they follow the rule and live through the entire 30-year period, they’ll usually end up with a big legacy, one they won’t be able to enjoy.
“A deeper look reveals that if a 2008 or even a 2000 retiree had been following the 4% rule since retirement, their portfolios would be no worse off than under any of the other ‘terrible’ historical market scenarios that created the 4% rule from retirement years like 1929, 1937, and 1966,” wrote Kitces in a blog post
Wednesday. “To some extent, the portfolio of the modern retiree is buoyed by the (only) modest inflation that has been occurring in recent years, yet even after adjusting for inflation, today’s retirees are not doing any materially worse than other historical bad-market scenarios where the 4% rule worked.”
The safe withdrawal rate was devised to ensure that inflation-adjusted spending is sustainable even in the worst-case scenario.
Historically, the median withdrawal rate using a 60/40 (equities/fixed-income) portfolio is 6.5%. Better still, the median wealth at the end of 30 years was almost three times a retiree’s initial wealth.
“The overwhelming majority of historical scenarios do not necessitate a 4% rule, or anything close, and come out with a significant excess of unspent wealth at the end,” Kitces wrote. And by withdrawing only 4%, and allowing the portfolio to compound higher, the reality is that the 4% rule actually has a remarkably high probability of leaving over a significant amount of remaining wealth by the end of the 30-year time horizon.”
That’s great for a client’s beneficiaries but probably not so good for them.