When you become deluged with statements and communications for retirement plans, you may find it frustrating to grasp the unified picture. Bringing the accounts together will help you rebalance and keep a handle on your overall rate of return. Although you may believe that having more accounts will help add diversification, that may not be true. If the holdings overlap, the duplications will cancel out the advantages of spreading bets. Besides, your risk tolerance profile and financial goals are likely to change over decades.
How Much Can You Withdraw During Retirement?
The magic number for retirement is 4%. If you calculate that portion of your liquid assets in the year you hang up your hat and thereafter continue to adjust each year for inflation, you should be covered for about three decades. Or so the theory goes. But since it was first created in the mid-1990s, financial planners have come up with several caveats and refinements in the search for the ideal balance between overindulging and scrimping.
Playing by the rule
Bill Bengen, who invented the 4% rule and published it in a 1994 research paper, studied stock and bond market returns from 1926 to 1976. He found that, even in the most challenging markets, using his rule, retirees could rely on adequate funds for 33 years. Life expectancy might be an additional factor. Would 33 years suffice for a lengthy retirement?
But Bengen has subsequently had second thoughts, based on fresh research. The creator himself fears the rule may have been oversimplified and worries that the returns data might be overly influenced by the drastic market downturns in the 1930s and 1970s. Perhaps, as the father of the 4% formula reflects, retirees could increase their withdrawals to 4.7% and still be protected. But wait! Bengen has revised his thinking once more, spooked by higher inflation since the pandemic. It might be more prudent after all, he reconsiders, to aim for 4.5% or 4.4%.
Another aspect of the rule is how to allocate assets in the retirement portfolio. The original rule advocated an evenly divided mix of common stocks and intermediate-term treasuries. That prescription, too, has evolved. In today’s climate, Bengen suggests 55% for stocks and a much smaller bond allocation.
Tweaking and revising
Inflation, which has dramatically resurfaced, is a key element. It is fine to advise retirees to adjust their math to factor it in, but which measure should they use? Although the Federal Reserve uses a target rate of 2%, it might make more sense to consider cost-of-living increases. In fact, in 1998, three finance professors from Trinity University concluded that retirees would need a rate below 4% for consumer price index-adjusted withdrawals. Those Trinity authors revisited and reaffirmed the rule in 2011.
Another difficulty is that the rule demands strict adherence. Followers are supposed to make a firm commitment to it, with no exceptions for big outlays.
In a broader context, many people tend to retire at market peaks, especially older workers who may be struggling to find employment. Yet that may prove the riskiest time to retire, as markets are about to turn downhill. They face the problem that their withdrawals will be more expensive in a bear market, while their accounts are shrinking without new inflows. If their needs remain fixed, with little room to pare down discretionary spending, then, more than ever, they could use some cushioning.
Lastly, the 4% rule does not account for taxes, investment fees, IRA withdrawals (including required minimum distributions after 72) and other income sources, such as pensions, annuities and Social Security.
Needs change
Life is unpredictable. A rigid retirement rule should not become constraining. Most people’s needs and wishes alter from one year to another, whether regarding medical bills or leisure activities. Longer term, spending patterns change throughout retirement: Most spend more in the first years, whether on travel or hobbies; then they hit a lull before finally increasing outlays on health spending later. Unfortunately, the 4% rule — or some variation of it — is not dynamic enough to capture that rhythm.
No single perfect answer exists. The best solution is to stay flexible and review your spending rate annually. If markets enjoy a boom, you might want to add a few “nice to haves.”
Although the 4% rule is great to keep in mind, your best bet is working closely with your financial adviser, who can help you adjust some version of a withdrawal rule to fit your personal needs and circumstances.
t their heirs to hear and advice about finances they want to pass down.
