The general guideline of withdrawing
no more than 4% of your portfolio each year during retirement has come
under fire as of late. This guideline was the result of a study
conducted almost 30-years ago by William Bengen, at
a time when it was believed that 5% was a safe withdrawal rate. In the
study William determined that 5% was too risky, and proposed the change
to 4%.
Based on PAST historical returns, the 4% rule appears to be valid BUT prolonged periods of very low returns on bonds in recent years suggest that withdrawing 4% per year adjusted for inflation is no longer a safe guideline.
Research by Michael Finke, Ph.D., CFP®
Wade D. Pfau, Ph.D., CFA
David M. Blanchett, CFA, CFP®
suggests that the rule is no longer a valid guide because of persistently low interest rates.
The 4% Rule is Not Safe in a Low-Yield World
Executive Summary:
"The safety of a 4% initial withdrawal strategy depends on asset return assumptions. Using historical averages to guide simulations for failure rates for retirees spending an inflation-adjusted 4% of retirement date assets over 30 years results in an estimated failure rate of about 6%. This modest projected failure rate rises sharply if real returns decline.
As of January 2013, intermediate-term real interest rates are about 4% less than their historical average. Calibrating bond returns to the January 2013 real yields offered on 5-year TIPS, while maintaining the historical equity premium, causes the projected failure rate for retirement account withdrawals to jump to 57%. The 4% rule cannot be treated as a safe initial withdrawal rate in today’s low interest rate environment.
Some planners may wish to assume that today’s low interest rates are an aberration and that higher real interest rates will return in the medium-term horizon. Although there is little evidence to support this assumption, we estimate how a reversion to historical real yields will impact failure rates.
Because of sequence of returns risk, portfolio withdrawals can cause the events in early retirement to have a disproportionate effect on the sustainability of an income strategy. We simulate failure rates if today's bond rates return to their historical average after either 5 or 10 years and find that failure rates are much higher (18% and 32%, respectively for a 50% stock allocation) than many retirees may be willing to accept.
The success of the 4% rule in the U.S. may be an historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio."
SO... what to do. No one ever really recommended that you rigidly follow the 4% guideline every year regardless of portfolio returns. Besides, our need for income fluctuates over a 25-30 year period. Duh! Thus, it is prudent to to make adjustments to balance out returns and needs over a retirement lifetime.
What is "sequence of returns risk"?? If you are lucky to retire during a decade of high investment returns, you may end up with more money than you started with at retirement. However, if the first 5-10 years of your retirement yield negative returns... you're in trouble.
Another factor to consider is
the benefit of investing a portion of your retirement into a lifetime annuity to ensure that, along with Social Security, you won't run out of money.
