Revisiting the 4% Rule

Revisiting the 4% Rule 
(Vanguard, August 29, 2012)

The authors from Vanguard remind us that the 4% Rule isn't really a simple rule--the 4% rate of withdrawal needs to be adjusted for life expectancies different from 30 years and different investment mixes (as well as inflation after retirement).  They also note that it is unlikely that retirees actually follow the 4% rule for their entire retirement, stating, "more realistically, retirees continue to monitor their portfolios and spending, adopting some level of flexibility to account for changes in market returns and unplanned spending needs." 

The withdrawal rates contained in Figure 2 of the Vanguard paper are reasonably consistent with withdrawal rates using the spreadsheet on this website with assumptions of 5% investment return, 3% inflation, no annuity income and no amounts left to heirs.  Of course, retirees with annuity income and/or plans to leave significant amounts to heirs may have to make additional adjustments to the Vanguard withdrawal rates shown in Figure 2.  Alternatively, we would suggest that you simply use the spreadsheets and methodology contained in this website.

What Will $1 Million Get You in Retirement?

What Will $1 Million Get You in Retirement? 
By Douglas Carey (AOL Daily Finance, 11/9/12)

Author argues that under his assumptions and the Monte Carlo method, a couple planning for 30 years of retirement invested 70% in equities and 30% in medium duration Treasuries has an 80% probability of not outliving their $1 million retirement savings if they withdraw $55,000 in the first year of their retirement (and increase that amount by inflation each year).   While his assumption for annual investment return on equities is shown as a "more reasonable" 6%, this is a real (after inflation) rate of return assumption on equities, and therefore his nominal investment return assumption on equities is approximately 9% per year, based on his assumed inflation assumption of 3% per annum.  If you input a 30-year life expectancy, 7.65% investment return (70% at 9% and 30% at 4.5%) and inflation of 3%, you will get a first year withdrawal rate of about 5.9% in the spendable calculator on this website.  So, a $55,000 initial withdrawal from $1 million of accumulated savings may be reasonable for a 30-year retirement period if you plan to be invested 70% in equities throughout your retirement and you believe you will achieve a 6% real rate of return on those assets.   Retirees who feel somewhat less bullish about equity investments may wish to run the spreadsheets and develop withdrawal strategies based on lower real rate of investment return assumptions.

Can Retirees Base Wealth Withdrawals on The IRS' Required Minimum Distributions?

Can Retirees Base Wealth Withdrawals on The IRS' Required Minimum Distributions? 
by Wei Sun and Anthony Webb (Retirement Research at Boston)

My snarky reply to the question posed by the title of this paper is, "Of course they can, but should they?"  Apparently, they used "should" in their working paper, so they felt they couldn't use it in this follow-up paper. 

The authors compare several common withdrawal strategies with what they define as an "optimal withdrawal strategy."  Based on their comparisons and assumptions, they conclude that the IRS rules for Required Minimum Distributions (RMDs) and a modified version of RMDs outperform the other commonly used approaches (including the 4% withdrawal rule discussed in this site).

While I'm not a big fan of the 4% withdrawal rule for many of the same reasons noted by the authors, I'm not ready to buy that RMD or modified RMD approaches are either easier to implement or more "optimal" than the approach set forth in this website.  In developing their optimal strategy, the authors ignore a number of factors that may be important to retirees, including:

• Stability of total retirement income from year to year in real dollars (or flexibility to have increasing or decreasing real income from year to year).
• Coordination of the withdrawal strategy with other sources of retirement income, such as annuities
• Desire to leave inheritance

Therefore, while I agree with the authors that the RMD approach has the advantage (over the 4% rule) of automatically adjusting for actual experience, there are several downsides to this approach that may not please all retirees.  Retirees should be skeptical of any withdrawal strategy (even the one suggested in this site) that claims to be "optimal."

How to make your retirement savings last

How to make your retirement savings last 
(CNN Money, October 12, 2012)

Safe Withdrawal Rates: What Do We Really Know?

Safe Withdrawal Rates: What Do We Really Know? 
(Michael E. Kitces, Journal of Financial Planning) 

The 4% Withdrawal Rule?  Really?  Is this the best advice the financial expert community has to offer?  Withdraw 4% (or some other "safe" withdrawal percentage) of your accumulated savings in your first year of retirement and then blindly increase that amount for inflation for the rest of your life (or until you spend all your savings, whichever comes first).  You do this without adjustment for actual investment experience,  actual price inflation, changes in heath or variations in amounts withdrawn.  Am I the only one who finds the 4% Withdrawal Rule crazy?  If you want to self-insure some or all of your retirement, you need to use an approach (such as the one described in this website) that adjusts for actual experience.

Fidelity Outlines Age-Based Savings Guidelines to Help Workers Stay on Track for Retirement

Fidelity Outlines Age-Based Savings Guidelines to Help Workers Stay on Track for Retirement 

(Fidelity, 09/12/12)

Fidelity issues "age-based savings guidelines" concluding that a typical person retiring at age 67 should accumulate at least 8 times final annual pay to secure an 85% replacement income in retirement.

Based on our understanding of the assumptions noted in this news release and the methodology outlined above, we have confirmed Fidelity's 8 times final pay calculation, but caution individuals who may rely on this study that one of the assumptions made by Fidelity may be overly optimistic and therefore understate the accumulated savings needed.   Fidelity has assumed that accumulated savings will earn a REAL rate of return of 5.5% per annum, or a nominal return of almost 8% per year based on their assumed rate of inflation of 2.3% per annum.  Individuals planning for retirement or developing spending strategies in retirement may wish to utilize a more conservative annual investment return assumption.

Can you trust retirement calculators?

Can you trust retirement calculators? 
Steve Vernon (August 10, 2012, CBS MoneyWatch)

A nice article by Steve Vernon showing that amounts produced by popular retirement savings calculators vary dramatically.  Steve is an actuary I worked with for many years.  He writes well-reasoned retirement articles for CBS MoneysWorth.  Here is a link to his recent articles.  
http://www.cbsnews.com/2741-505146_162-1348.html?tag=contentBody;correspondant

IRS Proposes Neat New Way to Address Retirement Longevity Risk

IRS Proposes Neat New Way to Address Retirement Longevity Risk 

One of the big problems in determining how much of your accumulated savings you can spend each year in retirement results from the necessity of having to plan on living well into your 90s to make sure that you have enough money in case you actually live that long.  While this risk can be managed by buying an immediate annuity, many retirees balk at using most of their accumulated savings to purchase an immediate annuity when what they want is an annuity that starts at a later age.  However, the government's current minimum distribution rules under Section 409 of the Internal Revenue Code made purchases of annuities that deferred commencement after age 70 in qualified defined contribution plans or IRA's difficult.  In a welcomed change of policy, the new proposed rules would permit a specified portion of accounts in such plans to be used to purchase a "Qualified Longevity Annuity Contract" (QLAC) without affecting the minimum distribution rules for the remainder of the account.
 
Under the proposed regulations, premiums for the QLAC could not exceed the lesser of 25% of the account balance or $100,000.  The QLAC would provide for distributions to start at some date in the future but not later than when the contract holder attained age 85.  No benefits could be provided under the QLAC after the contract holder's death other than life annuities payable to designated beneficiaries.
 
More detail can be found in the proposed regulations published in the Federal Register on February 2 of this year.  It is important to note that under the proposed rules, QLACs will not be available (and therefore cannot be used) until the proposed regulations are finalized. 

Is the 4 Percent Rule Viable?

Is the 4 Percent Rule Viable? 
Ruffenach: A fresh look at the 4 percent retirement-withdrawal rule.
Glenn Ruffenach (SmartMoney, January 17, 2012)

Excerpt: "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."