Redoing the math on a 4% retirement withdrawal rate

The seemingly endless debate across the financial planning industry over retirement withdrawal rates appears to hover over the consensus that 4% is a good place to start. Beyond that, advisers and analysts disagree about what amount is currently “safe,” and revert to a need for flexibility based on everything from Social Security income and health issues to home equity levels and market cycles.

“No one really knows what their safe withdrawal rate will be until they’re actually in retirement,” said Blair duQuesnay, chief investment officer and principal at ThirtyNorth Investments, which manages $135 million in client assets.

The financial planning industry has been loosely following and aggressively debating the 4% rule for more than two decades, following publication of the influential standard in the Journal of Financial Planning in 1994 by now retired financial adviser William Bengen.

According to Mr. Bengen’s research, which was based on historical worst-case-scenario market simulations, an individual could withdraw up to 4% from a portfolio in the first year of retirement, followed by the same dollar amount adjusted for inflation each year thereafter for 30 years, without running out of money.

While the planning industry loves to banter about ways to tweak the rule, 4% remains the foundation from which to make adjustments.

“I’ve never used 4% as a planning criteria, but it’s been a good education framing tool,” said Harold Evensky, chairman of Evensky & Katz.

“Today, 3.5% is probably even better,” he said.

The lower withdrawal rate puts Mr. Evensky in the camp of those playing extra defense in deference to the current low interest-rate, low-inflation environment.

But when you consider how the original 4% rate was calculated, factoring in the worst runs in modern market history, it can also be argued that 4% is too low.

“The 4% rule is meant to be conservative, because it’s calibrated to the worst-case-scenario in U.S. historical data. But the problem is, U.S. history is pretty good, so worst-case isn’t that bad,” said Wade Pfau, a professor of retirement income at The American College.

And, he said, longer life expectancies and lower interest rates could put pressure on the 4% rule.

“Maybe 3% makes more sense,” Mr. Pfau said.

While some advisers argue that 4% is too high a withdrawal rate given the current environment, others are making the case that 4% is too low.

Michael Kitces, partner and director of research at Pinnacle Advisory Group, has been a vocal proponent of higher withdrawal rates, unless the primary goal is to leave more money to be inherited.

By his analysis, looking at various 30-year market cycles dating back to 1870, a 4% annual withdrawal rate often leaves the investor at death with more than double his or her starting principal.

“The median wealth at the end — on top of the 4% rule with inflation-adjusted spending — is almost 2.8 times starting principal,” Mr. Kitces said. “It’s overwhelmingly more likely that retirees will have opportunities to ratchet their spending higher than a 4% rule, than ever need to spend that conservatively in the first place.”

Overly conservative or however flawed, the 4% rule remains a guide for retirement income planning for a lot of financial planners.

“It’s a starting point, and it sometimes depends on the market returns when you’re starting to draw the money out,” said Tracy Sherwood, senior financial adviser at Ogorek Wealth Management, which has $351 million under management.

“All the research on the 4% rule is interesting, and it’s good to know what happened historically, but the takeaway is you have to be flexible,” she said. “The applicability of the rule is different when you’re working with actual clients.”

Ms. duQuesnay likewise uses the so-called 4% rule as a starting point for retirement income, and as a tool to help clients better understand how much they will need to accumulate while they’re still working.

“So many young people can’t even fathom how much they will need in retirement, and that figure doesn’t always register until you draw it out for them as a withdrawal rate,” she said.

If younger savers have a hard time imagining how much they need to save, older savers have an equally difficult time imagining how much they might be able to spend.

A recent survey of pre-retirees over age 55 found that 38% believe they will be able to withdraw 7% or more annually from their retirement accounts.

In terms of relying too much on the 4% rule, Ms. duQuesnay said, “It’s a good rule to follow when accumulating assets, but in practice, people don’t live in a straight line.”