Thursday, January 22, 2015

Bud Hebeler's Autopilot Withdrawal Rule

I've been a big fan of Bud Hebeler and his Analyze Now website every since I retired and started this website.  In fact, his website was one the first one I listed in the "Other Calculators/tools" section of this website.

Bud writes many articles about retirement, and is featured as one of the MarketWatch Retirementors.  In his most recent article,  Bud touts the virtues of a fairly simple method of determining annual withdrawals from savings he calls the "Autopilot" approach.  While I don't think it is necessarily better than the Actuarial Approach advocated in this website, subject to the caveats discussed below,  I do think that it can provide you with another point of reference with respect to the amount of your spending budget that may be withdrawn from accumulated savings. 

Bud's autopilot approach involves taking 75% of last year's budgeted withdrawal increased with inflation for the previous year and adding 25% of what Bud calls the "Planning Method" (or Planner Method).  Under the Planning Method, all you need is a calculator (like the HP 12c) or an internet financial planner with financial functions, and you solve for the annual annuity payment (PMT) given the period of payments (n), the interest rate (i) and the amount of accumulated savings (PV).  Bud suggests using IRS Publication 590 life expectancy tables for "n" and an interest rate of 5% and inflation of 3.5%.  Note, if you are using the HP 12c calculator, you will be doing the calculations assuming beginning of year payments and an interest rate of 1.45%.

Let's take a look at Bud's suggested withdrawal rate at age 65 where the IRS 590 life expectancy is 21 years.  Bud's initial withdrawal rate at age 65 using the Planning Method would be about 5.5%.  By comparison, the withdrawal rate under the Actuarial Approach (using recommended assumptions) is about 4.3%.  The primary difference in the two approaches results from using life expectancy of 21 years under Bud's method vs. assuming a 30 year payment period under the Actuarial Approach.  We discussed why you might not want to use life expectancies for your retirement planning period in our post of Wednesday December 3, 2014, but perhaps Bud feels his conservative investment return/inflation assumptions counterbalance this somewhat unconservative longevity assumption. 

The Autopilot approach also uses a different technique to smooth actual experience and spending variations.  If readers like Bud's smoothing approach better than the smoothing algorithm we recommend, you could simply replace the "Planning Method" result with the result from our Excluding Social Security spreadsheet and use a combination of the two approaches. 

Caveats regarding the Autopilot rule:

  1. It assumes no bequest motive 
  2. It does not coordinate with other sources of retirement income such as immediate or deferred pension/annuities
  3. As discussed above, it recommends the use of life expectancy.  As the retiree ages, life expectancy (in years) will decrease but not by one year for each year of advanced age, so this approach will result in longevity experience losses that will decrease future withdrawals unless these losses are offset by other experience gains.