It has been almost 20 years since William P. Bengen released his groundbreaking research demonstrating that 4% is a sustainable withdrawal rate in retirement, but even now, the finding continues to shape advisers' approach toward retirement planning.
The fee-only financial planner and president of Bengen Financial Services Inc. became famous in the advisory industry when the Journal of Financial Planning published his paper “Determining Withdrawal Rates Using Historical Data” in 1994.
Mr. Bengen modeled a portfolio with a 50% allocation to stocks and 50% to bonds, using intermediate-term Treasuries as the fixed-income component. He determined that a client who started withdrawals any time between 1926 and 1976 could have lived off the portfolio for at least 30 years if he or she made 4% annual withdrawals that were adjusted for inflation.
Ten years later, Mr. Bengen added small-cap stocks to his model, boosting the withdrawal rate to 4.5%.
His research signaled a turning point for many in the financial advisory industry.
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For starters, it encouraged advisers to not rely entirely on strong markets as the sole basis for determining withdrawals in retirement. Outsized returns don't imply that it is safe to take outsized withdrawals.
“He brought systematic and quantitative analysis. It wasn't just this complete guesswork where if the market gives you 7% returns on average, then you can withdraw 7%,” said Wade D. Pfau, professor of retirement income at The American College.
“Bengen says that if your portfolio declines in value, then it doesn't have as much of a chance to return to its peak because you're taking income out,” Mr. Pfau said. “He uncovered sequence of returns risk and brought the perception [of a safe withdrawal rate] down to 4%.”
STICK WITH THE FIGURE
Researchers continue to build on Mr. Bengen's findings, adapting them for today's conundrums: low interest rates and the damage they do to bond returns.
For instance, David Blanchett, head of retirement research at Morningstar Inc.'s investment management division, authored a study this year that found that clients can safely withdraw only 2.8% over a retirement period of 30 years if they allocate 40% of their portfolio to stocks. Low interest rates and the damper on bond returns is the reason the withdrawal rate has been slashed.
Mr. Pfau was one of the co-authors of that paper.
Meanwhile, Mr. Bengen, 65, said that while he has kept a close eye on the latest research, he hasn't changed his views on retirement income withdrawal rates.
“It means that retirees will get their 30 years of income and then run out with their dying breath,” he said. “I think in the next few years, we'll have a downturn, and I'm taking steps to lighten up on stocks and wait for better prices, but nobody is in real trouble.”
Mr. Bengen has acknowledged, however, that there is plenty of room to discuss tweaks to retirees' spending habits if they become excessive.
Further, clients ought to think about the way they invest.
“When we came up with the 4% and 4.5% withdrawal rates, we assumed you would be a buy-and-hold investor,” Mr. Bengen said. “But now they might be able to reduce the volatility of their portfolios in order to keep that 4.5% rule going.”
The adviser has also kept track of a cohort of his clients who retired in 2000, amid the technology crash. These clients have been managing on their 4.5% withdrawal rates and have been fortunate enough to live through a couple of steep market declines and recoveries without the specter of rising inflation.
The rule will unravel in periods of high inflation, which can lead to rapidly rising and unrealistic withdrawal rates.
“The last 12 years haven't been all that bad. We haven't had inflation,” Mr. Bengen said. “But if we did, it would be completely different.”
There are other ways to ensure that clients are able to sustain their withdrawal rates, Mr. Bengen said.
“Many people are house-rich and cash-poor in retirement. Maybe they should look at home equity and use a reverse mortgage,” Mr. Bengen said.
“I wouldn't start by cutting your rate from 4.5% to 3%,” he said.
“There are alternatives to look at, including reverse mortgages, annuities and changing the way you invest. You can live reasonably comfortably,” Mr. Bengen said