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Your retirement: Is the 4% rule viable?

One study says a safe withdrawal rate for a retirement begun in 2010 was only 1.8%. Another says 7% is OK for some. How can you make sense of this?

By MSN Money Partner Feb 7, 2012 12:10PM

This post comes from Glenn Ruffenach at partner site SmartMoney.

 

SmartMoney on MSN MoneySo you've put the finishing touches on your retirement plan, and you're set to withdraw 4% from savings each year, because that's what financial planners (and columnists) have long advised.

 

Can you guess what's coming?

 

Last year, a research paper in the Journal of Financial Planning predicted that a safe nest-egg withdrawal rate for retirements begun in 2010 is 1.8%. In other words, a new retiree with $500,000 should pull no more than $9,000 from savings annually to help ensure that his money lasts as long as he does. Stunned? Wait. There's more.

 

Within weeks of that report's appearance, a study in Retirement Management Journal made the case that a safe withdrawal rate for some individuals could be as much as 7%. Which means the same person with $500,000 could start retirement by pulling about $35,000 from savings annually.

 

See? Isn't retirement planning fun? In fact, both papers make some intriguing points. (We'll get to them in a moment.) But here's the real lesson: Retirement planning -- or rather, good retirement planning -- is never really finished. Ideally, your particular plan is open to new ideas and research and, as such, is able to evolve.

 

Take the so-called 4% rule. Based on pioneering work in the early 1990s by William Bengen, a certified financial planner in El Cajon, Calif., the rule states that retirees can pull about 4% annually from their nest egg, with a high probability that their savings will last 30 years. (Bengen himself eventually set the figure at 4.5%.) The findings helped establish budgets and spending patterns for countless individuals.

 

Recently, though, researchers have been investigating how additional variables -- investment fees, the timing of retirement, retiree spending patterns -- could affect Bengen's benchmark. Here's what some of that work might mean for your retirement. Post continues below.

On your mark

"Market valuations" -- the relative health of markets at the moment you enter retirement -- are now an important part of calculating withdrawal rates. The thinking: Markets move in cycles (bull markets follow bear markets, and so on), and we can measure (to some extent) whether we're on the cusp of the former or the latter.

 

Why is that important? If you happen to retire at the start of a bear market and withdraw too much too soon, your nest egg might expire before you do.

 

In his study in the Journal of Financial Planning, economist Wade Pfau notes that when price/earnings ratios (to cite one marker) are at or above historical averages, as they are today, investors in coming years are more likely to see anemic returns. As such, a new retiree would want to keep his initial withdrawal rate on the low side -- perhaps as low as (gulp) 1.8% -- to weather coming storms.

 

Care to gamble?

Most research into withdrawal rates assumes retirees, in effect, want a guarantee that their savings will last 30 years or more. But what if you're willing to gamble? Would you risk having (virtually) no savings for a brief period late in life in order to draw more early in retirement? Having a pension, for instance, might make that a risk worth taking.

 

That's the question Duncan Williams and Michael Finke, a doctoral student and professor, respectively, at Texas Tech University, tackle in Retirement Management Journal. One possible answer: Some risk-tolerant retirees could start with a withdrawal rate of 7%.

 

And what if you're risk-averse?

Even a 95% chance of success, when it comes to a nest egg's long-term survival, "may still represent a significant risk," says Ed Easterling, the founder and president of Crestmont Research, a Corvallis, Ore.-based investment-research firm. His example: A surgeon tells you she has a sterling 95% success rate with the operation she's about to perform -- and mentions that she operates 20 times a week. That means, of course, that one surgery per week, on average, will go bad. Easterling's point: A 95% success rate might sound good to others -- but is it good for you?

 

Running the numbers

Financial coach Todd R. Tresidder, founder of FinancialMentor.com, offers a four-step method for figuring withdrawal rates that reflects much of the recent research: Estimate your life span, assess market valuations at the time you retire, account for variables like inflation and investment fees and revisit your plan regularly. Tresidder is confident that investors can run the numbers themselves -- but I'm less so. Get your adviser to help with this.

 

Holding its value

And what of Bill Bengen, father of the 4% rule? One of the most affable people in the financial-planning industry, Bengen has never claimed that his findings are right for every retiree. Indeed, he thinks some of the latest research about market valuations is "terrific."

 

He told me recently that he started with a specific set of assumptions: a retirement lasting 30 years, with savings in a tax-deferred account and nothing left for heirs. Change just one of those parameters, he says, and your "safe" withdrawal rate may differ.

 

Still, Bengen notes, 4% remains a prudent jumping-off point for calculating withdrawal rates from nest eggs. Just keep your plan open to some adjustments.

 

More on SmartMoney and MSN Money:

20Comments
Feb 8, 2012 1:56PM
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My husband should have 300-350K in his 401k by the time he retires (about 6 years) if everything goes as planned (very conservatively invested) which will make him about 67.  We will use the 401k money and his pension to put off drawing SS til 70 when he gets the higher amount. He is in good health and with his family history there is a good chance he will live to his mid 80s. Our house will be paid off and no other debt except maybe one car payment.

So we may start off at a higher withdraw rate of about 36k per year for three years and then drop down to a lower rate(18k) when SS kicks in

The 401k will last about 14-15 years by which time i will be retired. Right before i retire we will sell off the house and move into a smaller, easier to care for home and pocket the difference for future use.

Then, of course there is my income but we can just live off his if we have too

So as you see, for most of our retirement we will be taking over 7% out and it still works for us

 

Of course i haven't planned for all possible outcomes, so if the stuff hits the fan things could change. But we have a plan and i am not going to live in poverty on the off chance he has a stroke tomorrow.

Feb 8, 2012 2:32PM
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This article is irresponsible at best. Create a panic in the open to catch attention and then offer up the answer that there is no problem at all by saying that 4% is still a “good jumping off point” to conclude the article. Wow, that was enlightening…

 

The fact is that actuaries still know that over time investment accounts will produce returns near long term trends, maybe higher given the starting point, and that is why insurance companies are now offering retirees five, six and higher percent guaranteed withdrawal rates for lifetime payouts. Hey folks, insurance companies are not in business to lose money.

 

I’m going to let you in on a little secret…there is no new paradigm for investing. Invest in good companies, collect dividends and buy more shares with those dividends. Lather rinse and repeat.

 

Once people’s expectations are focused on long term total return and not short term success, only then will they succeed at investing.

Feb 8, 2012 3:32PM
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Personally, I expect and hope to be able to do a lot more things early in my retirement than later.  If I don't have a lot left when I'm say 85, so be it, because by then I won't likely be driving a car, playing golf or doing much traveling so I plan on withdrawing more early on so I can do those things while I'm young and healthy enough to enjoy them.
Feb 8, 2012 4:29PM
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I'll start by saying I'm not a CFP or certified in anything financial, but i've used a few assumptions over the years and they have recently been updated.

Number one - please figure on inflation. I now use 3.5% annually, or figure the price of stuff will double every twenty years. So if you think you'll need 50K a year when you retire at 60, you'll want to be generating 100K annually when you hit 80.

Number two - be realistic about what you'll likely spend. Don't say things like "I'll probably just need about 70% of my income." Do the math and see what your bills will likely be (with things like increased medical costs, pricier insurance, no house payment, lower taxes after retirement, etc) and then look at what you would like to do - travel, golf, garden - and put a price on those things. Only by doing that will you really get a grip on what you'll most likely need.

Number three - decide if you want to have anything left over to pass on to the kids and/or spouse and then work backwards from there. Having an amount left over (I recommend a pretty good size chunk) gives you the ability to live longer and still have money left over. In other words, if you plan to run out of money at 90, and you do, but you live to 96, your last 6 years are going to suck. Think about the "inheritance" as being a kind of "insurance" for you. Hey, if you die early, the worst that'll happen is the people who outlive you will have more money than you were going to give them.

Finally - put it all on paper. I use a spreadsheet, and run the numbers with different inflation numbers, rates of return, starting amounts, spending amounts, and life expectancies. It takes some time, but it seems worth it for such an important thing. You can have a planner help you, just make sure they know what they're doing and that they listen to your concerns. The more you dig into it, the easier your decisions will be to make.

Good luck, and if you take some time, you'll be able to get there. Unless you're 65 and only have 30 grand. 

 

Feb 8, 2012 3:56PM
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So I should scrimp and save all my life until retirement to get to $500,000, then scrimp and save until I die. Nice. Life is good.
Feb 8, 2012 3:08PM
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The 4% rule? I've never heard of the "Medium" T-shirt rule. One size does not fit all.
Feb 8, 2012 3:57PM
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My husband should have 300-350K in his 401k by the time he retires (about 6 years) if everything goes as planned (very conservatively invested) which will make him about 67.  We will use the 401k money and his pension to put off drawing SS til 70 when he gets the higher amount. He is in good health and with his family history there is a good chance he will live to his mid 80s. Our house will be paid off and no other debt except maybe one car payment. So we may start off at a higher withdraw rate of about 36k per year for three years and then drop down to a lower rate(18k) when SS kicks in  The 401k will last about 14-15 years by which time i will be retired. Right before i retire we will sell off the house and move into a smaller, easier to care for home and pocket the difference for future use. Then, of course there is my income but we can just live off his if we have too So as you see, for most of our retirement we will be taking over 7% out and it still works for us

 

I see another person who simply doesn't have enough tucked away.  One major health crisis, and the 401(k) is instantly emptied.  Not putting money aside for health crisises is the primary reason most peoples retirement funds fall short.

Feb 8, 2012 3:54PM
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"What me worry?"  The so called "Progressives" will have it all figured out.  The Federal Government will provide for my every want and need until the day I die.  I can just spend my money now, even run up outrageous debts, and I'll be fine.   Think I'm joking?   50% of our country is banking on it.
Feb 8, 2012 2:03PM
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so, then is 4% of $100.00 is good right? I am set for life huh?
Feb 8, 2012 3:59PM
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"What me worry?"  The so called "Progressives" will have it all figured out.  The Federal Government will provide for my every want and need until the day I die.  I can just spend my money now, even run up outrageous debts, and I'll be fine.   Think I'm joking?   50% of our country is banking on it.

Please, stop it.  Progressives do understand that the vast majority of people will frankly never save up for retirement, and thus want programs that ensure there is at least a bare minimum saftey net in place.  Then again, if people still had guranteed pension plans, or at least got enough raises to cover inflation, there wouldn't need to be so much money wasted on such programs in the first place.

Feb 8, 2012 2:00PM
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So.......apparently no one knows what the correct rate is!

This is not a one size fits all folks. It depends upon your lifestyle and if you are trying to leave something for the children. What most if not all of these plans leave out is the fact that you need more money in the first portion of your retirement and less in the second portion. In the beginning you plan to live as closely to your current lifestyle as you can while in the later years (80-85+) you will not be as mobile, you will not eat as much, etc.. But the medical cost will be higher. So back to my original statement no one knows.

Feb 8, 2012 4:17PM
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Based on the fact that many in my area seem to kick off within 5 years of retirement one could easily draw 10%. I don't plan on living to retirement so I'm good.........................
Feb 8, 2012 1:56PM
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Good article. I believe many classic assumptions about investing are no longer valid in today’s wacky markets and economy. The huge increase in government intervention alone makes it impossible for things to remain the same. In my long range planning, I now assume that my investments will lose 2-3% of their real purchasing power over time, after inflation and taxes. I’m praying that assumption is conservative enough to carry me through. Good luck finding a financial adviser who will tell you to do the same. Even if they believe it themselves, they know such advice will never help them get or keep you as a client.

Feb 8, 2012 3:52PM
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Depends on rate of inflation, and yield of money. 

Inflation depends on how much Uncle Sam prints and gives away.

Uncle Sam has set the yield at  ZERO. 

That's a hard combination for the average person, fine for the banks.

 

 

Feb 8, 2012 4:28PM
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I don't think any flat % can or should be assumed for retirement withdrawls. As this article points out, market conditions change what you are able to pull out at any given time. 

 

The bottom line is: save as much as you can, invest your assets wisely, and consider other income streams besides 401ks and Social Security (rental properties, home equity, small businesses, part time jobs, etc.)

 

Anyone who tries to incorporate some magical withdrawl/investment return number to figure out the bare minimum to invest is going to hit the same brick wall that all the defined benefit pension plans have. You have no way of knowing for sure how long you will live, your lifetime income, or the market return.

Feb 8, 2012 5:37PM
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This article does not take into account the RMD. If you have a pre-tax 401K, 403B etc the Fed tells you every year the minimum amount you can take out (after age 70.5). I did a spreadsheet to figure out to age 107 (my grandfathers age when he died) and  based on the govt.'s calculations how much I should take out every year. I also figured in taxes as the amount you withdraw can affect the amount of taxes you will pay on Social Security benefits. So far the spreadsheet has worked well for me.
Feb 9, 2012 3:46PM
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So you work hard and save a million dollars.  Being conservative you withdraw annually just the 1.8%, which gives you  $18,000 a year.   At that rate of withdrawal and even with zero return on investment your money will last for 55 years.  But who is planning to living to 120 and why would a millionaire settle to live on $18,000 a year?
Feb 8, 2012 7:05PM
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Please, can some help me to understand? The first part of the article says that some research paper concluded that someone retiring in 2010 with a nest egg of $500k should only withdraw 1.8% = $9,000 per year. Huh? First of all, by withdrawing $9k per year, after 30 years only $270,000 would have been withdrawn. What about the other $230,000 not to mention whatever interest/investment returns would have been earned (at least supposedly) during those 30 years? What's the rationale behind that? I just don't get it, so if you do, please explain it to me....
Feb 8, 2012 6:31PM
Feb 8, 2012 1:57PM
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Oh...those wacky 1%'ers...now where did I put that generic bologna after I made the morning sandwich my budget allows. My doc says to try and eat healthier, but I quit being able to see him or buy my meds long ago. Naps are good. You can forget about wondering where you will live when you are not only old, hungry, and broke, but homeless. And dream about how it was for the middle class when you were younger...before the Wall Street people,with the help of purchased politicians, destroyed life and transferred everything left to their portfolio, and dream about food....having money to stay warm, happy neighbors in the now- foreclosed houses around you. I like to read  history too. Throughouit the history of mankind, one thing you can count on 100% of the time,is that all...you... have ...to ...do... is ...wait.... Sweet dreams 1%. I'll just sit here and wait.
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