The question of how much retirees can withdraw has only grown more complex in recent years. In this episode of Plan Talk, Retirement Director Ben Rizzuto discusses why traditional approaches to decumulation – such as the 4% rule – should be viewed as starting points rather than one-size-fits-all solutions, especially with inflation on the rise.

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Ben Rizzuto: Hi, I’m Ben Rizzuto, and you’re listening to Plan Talk, from Janus Henderson Investors. Today I’d like to talk about an issue that faces each and every retiree: How much they can withdraw from their accounts on an annual basis?

One of the challenges many people in retirement face is that they are living longer. Certainly, that’s not bad news – it’s actually quite good news, but what it does mean is that the money that’s put away for retirement needs to last more years than perhaps we initially thought.

So once again, as people live longer, it means that the money put away for retirement needs to last that much longer.

Not only are people living longer, but there are a number of variables that go into this equation, which makes the decumulation problem one of the trickiest problems in finance.

The question that faces all retirees is how much they can withdraw from their accounts on an annual basis to meet their retirement expenses. In answering this question, one wants to make sure that they don’t withdraw too much or withdraw too little. It’s a classic goldilocks scenario, since if you withdraw too much, you run the risk of running out of money before the end of retirement, and if you withdraw too little, you leave money on the table and may inadvertently limit your level of enjoyment in retirement.

So for example, if your account balance at the beginning of retirement is $500,000, your first year withdrawal would be $20,000. That’s $500,000 times 4%. Then if we assume a 2.5% inflation rate, your second year withdrawal would be $20,500, that’s $20,000 from the first year plus 2.5% for inflation.

Now, research has since varied over the years since 1994, with some arguing that the annual inflation adjustment is unnecessary and that the lack of flexibility in the 4% rate doesn’t allow for market volatility and lifestyle changes over time.

Most recently, Morningstar released research that brought this quote-unquote rule into question. Through their analysis, they believe that the withdrawal percentage is now just 3.3%. Interestingly, Mr. Bengen quickly responded saying that his updated estimate would be 4.7%.

So, what is the answer? Well, as much as I would like to give you one number that works for everyone, I can’t. There is no “right” answer for everyone. It, like many things, depends. Your situation is different than mine, so your withdrawal percentage is going to be different than mine. The 4% rule may work on average, but we do not live our lives on the average. Our financial lives are singular to us, so using a rule or average may not be useful for our specific situation. Now, that is not to say that these rules should be completely discounted. I do feel that they should be viewed as well-informed starting points.

So, if you use 4% or 3.3% or some other percentage as our starting percentage, you must then consider items which these rules do not consider. This would include medical expenses, market fluctuations and your personal tax rate. Plus, don’t forget inflation! Interestingly, the inflation rate assumption that has been used in many cases has only been 2.2%. And as we all know, inflation has been quite a bit higher of late, ranging from between 5.0% and 6.8% over the past few months.

Therefore, it’s important to sit down with your financial advisor and consider assets, expenses, your budget in retirement, and how these items may change over time.

The key word to note within the previous sentence is “change.” To expect everything to stay exactly the same, withdrawal rate included, from the start of your retirement to the end of retirement, is imprudent. We all have experienced years where the market does better, or the market tanks, or inflation is low, or expenses are higher, or income is lower … and throughout all of those periods, we make changes. Maybe it’s cutting back on spending or taking gains after a good year in the market. Whatever it is, the 4% or 3.3% rule should not be called rules, because as soon as changes occur, those rules may need to be broken.

But we must start somewhere, and because of that I do like 4%. Why? If nothing else, it makes the math easy. However, if you’d like to be more conservative – which could help ensure you don’t run out of money – use 3%. On the other hand, depending on your situation, you may want to use a higher percentage.

To figure out that starting point, it is again, important to sit down and do the math. Whether it’s at your kitchen table or with your financial advisor, be sure to review your assets, your expenses, your health care needs, and how these will change in the future. Consider your bequest intentions, taxes and your overall goals. Going through this process will help you figure out your withdrawal percentage and create a plan – but remember that changes may be required in the future. While we don’t like change, especially when it comes to money, having a plan and having reasonable expectations are key to retirement success and consistent, sustainable cash flows in retirement.

Now, if you’d like to see more details on how these “rules” are created, other research that has been conducted, which will includes some charts and graphs. Please check out my blog post on the Janus Henderson website where I’ve been able to go into more depth.

Until next time, thanks for listening today. I’m Ben Rizzuto and this is Plan Talk.

¹ “What’s Your Retirement Number? No, Not Savings – Life Expectancy. Rate.com.
² W. Bengen, “Determining Withdrawal Rates using Historical Data.” Journal of Financial Planning, October 1994.

 

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