Retirement experts advise staying nimble regarding 4% rule

When it comes to managing portfolio withdrawals for clients in retirement, financial advisors generally cling to the 4% rule, a perennial favorite that offers a rough blueprint but not a complete solution.

According to experts speaking at an InvestmentNews Retirement Income Lab, nuances abound when it comes to preparing for the decumulation phase of retirement saving, but that doesn’t mean a 4% withdrawal target isn’t a good starting point.

“Retirees need some rule of thumb, and 4% is a decent baseline that accumulators use,” said Christine Benz, director of personal finance at Morningstar.

The devil, however, is in the details, as co-panelist Hugh Meyer, director of private wealth at Highline Wealth Partners, explained.

“Mortality rates are getting higher and Americans now are living into their 90s,” Meyer said, citing a study by Fidelity Investments that showed a couple in retirement in 2022 would need up to $300,000 just to cover health care expenses during retirement.

“From a financial planning perspective, we start with the concept of preparing for risks and uncertainty,” he said.

Meyer not only bangs the drum for more financial literacy efforts at earlier ages, but for shoring up portfolios in preparation for the current reality of higher inflation and economic uncertainty.

“The current volatility of rates and inflation will probably be with us for a while,” he said. “Having more cash and being paid to hold cash with higher yields is prudent.”

In terms of asset allocation strategies, Benz favors the popular bucket approach that separates a client’s portfolio into various near- and longer-term targeted needs and objectives.

While she sees the value of holding cash, especially with yields being pushed higher by the Federal Reserve, Benz said savers at all stages need to embrace a certain degree of risk to keep pace with inflation.

Benz said advisors need to prepare clients for what she described as a retirement spending “smile pattern” that starts with more spending during the early years of retirement.

“Once retirees reach their late 70s and early 80s, spending declines” as they become less active, Benz said. “Then the spending heads up later in life to address unfunded health care expenses. And long-term care expenses can crop up, especially for people who live a really long time.”

Benz also addressed the unique challenges of people who retired over the past couple years as inflation spiked to levels not seen in 40 years.

“If inflation is elevated early in retirement, those higher costs build upon themselves,” she said. “Even if inflation trends down, those costs stay somewhat elevated. That needs to be part of the discourse when discussing sequence risks.”

One unique aspect of inflation when it comes to retirees is that those people at the lower end in terms of income are hurt less by inflation because of the Social Security adjustments made to keep up with inflation.

“Inflation hits lower-income retirees less, because they’re relying more on Social Security and the government stepped in and adjusted payments,” Benz said. “The higher-income folks who are drawing more of their retirement needs from their investment portfolio really need to lay the groundwork in their portfolios.”

Regardless of account size, Benz said, “Job one is to look at expenses and isolate fixed from discretionary expenses, then map it out and get granular about things like when you might need to buy a car or replacing a roof.”

In some instances, she added, “an annuity can come into play when looking at the fixed-expense piece.”

“I like a plain-vanilla fixed annuity coming into play with fixed-expense shortfalls,” Benz said, but added that a potential negative for annuities is the impact of inflation.

“You can purchase an inflation rider, but you will pay for that considering where inflation is today,” she said. “That’s a fly in the ointment.”

Ultimately, as Meyer emphasized, the economic environment is dynamic, which means many traditional strategies need to be treated more as guides than specific rules.

“We’re in a different paradigm from an investor’s point of view,” he said. “We’ve been accustomed to the central banks coming to the rescue of our portfolios. I don’t think this volatility is going away, so we need to be proactive, and that means looking under the hood of investments and having a properly diversified portfolio.”