Low-rate environment means slower withdrawal pace: Study

Financial advisers who expect low interest rates to last might want to take a second look at clients’ withdrawal rates during retirement.

It seems that a 2.8% withdrawal rate over a retirement period of 30 years, with a 40% allocation to stocks, is the recipe for a 90% success rate if rates continue to stay low, according to a recent study by David Blanchett, head of retirement research at Morningstar Inc.’s investment management division.

Michael Finke, a professor at Texas Tech University, and Wade D. Pfau, an incoming professor at The American College, were co-authors of the study.

In the analysis, the writers assumed an initial rate of 2.5%, based on today’s rates and about the same yield on the Barclays Aggregate Bond Index as of Jan. 1. Rates were assumed to rise to normal after a five- to 10-year period.

The researchers used 30-day Treasury bills as a proxy for cash, the Ibbotson Intermediate-Term Government Bond Index to stand in for bonds, and the S&P 500 to represent stocks.

Over a 30-year period, the model assumes a 3.02% return on cash, a 5.14% return on bonds, bond yields at 5.01%, stock returns at 9.89% and inflation at 3.14%. The study also assumes a 1% fee to account for the cost of the investments and fees for the adviser.

Based on those assumptions, the traditional 4% initial retirement withdrawal rate over 30 years, with a 40% allocation to stocks, will lead to a 48.2% success rate, the study found.

The first five to 10 years are extremely important for retirees because low rates erode bond yields.

But rising rates will consume the value of the bonds, Mr. Finke said.

“When it comes to shortfall risk, those first five to 10 years are extremely important,” he said.

“It’s been suggested that one way to achieve higher yields is to raise the duration of the bond holdings, but that only exposes you to greater interest rate risk,” Mr. Finke said. “There is no easy solution for this problem.”

In the end, building the appropriate base for sustainable income in retirement will require clients to save more money, according to the paper.

“While the difference between a 3% initial withdrawal rate and a 5% initial withdrawal rate may not seem material, the 3% initial withdrawal rate requires 66.7% more savings than the 5% to produce the same annual income,” the re-searchers wrote.

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