Wade Pfau, an associate professor of economics at the National Graduate Institute for Policy Studies (GRIPS) in Tokyo, Japan, does most of his research on retirement-planning issues.
He earned a Ph.D. in economics from Princeton in 2003, under the guidance of professors Alan Blinder and Harvey Rosen. He also earned an undergraduate degree from the University of Iowa, and completed several internships at the U.S. Social Security Administration, the White House and the U.S. Senate.
You have done a great deal of work on retirement withdrawal rates. What does your research into international markets suggest to you about “the 4% rule”?
In the United States, there is a popular rule-of-thumb that it is safe to withdraw 4% of your accumulated wealth during the first year of retirement and then adjust this withdrawal amount for inflation in each subsequent year. Historically, your wealth will have lasted for at least 30 years.
My introduction to researching about retirement withdrawal rates was to look at the data since 1900 for 17 developed market countries. This paper was published as “An International Perspective on Safe Withdrawal Rates from Retirement Savings: The Demise of the 4 Percent Rule?”in the December 2010 Journal of Financial Planning.
From an international perspective, the 4% rule has not worked out so well. The historical worst-case withdrawal rate was above 4% in only 4 of the 17 countries: Canada, Sweden, Denmark, and the United States. For 30-year retirements, the 4% rule failed in 62.5% of the historical cases in Italy and in 42.5% of the historical cases in France. Five of these developed market countries experienced maximum sustainable withdrawal rates of 1.56% or lower.
In terms of returns for stocks and bonds, as well as for inflation, the United States enjoyed a rather remarkable run in comparison to other developed market countries in the period since 1900. This is important, because in planning for retirement in the future, it is not clear whether asset returns in the twenty-first century United States will continue to be as great as in the twentieth century, or whether savers and retirees should plan for something closer to the average international experience. We should be cautious about treating 4% as the safe withdrawal rate.
You have also looked at safe withdrawal rates in different domestic market environments. Are there special risks in this regard for today’s retirees?
Then I explored more about the United States and wrote two papers which each use a different method to suggest that withdrawal rates for recent U.S. retirees may be lower than for past retirees.
Before discussing this further, one point must be clear. If you are investigating, for example, retirement lengths of 30 years, then you cannot calculate the maximum sustainable withdrawal rate for any retirees after 1981. We don’t yet know if the 4% rule will work for retirees since 1981. But I am quite concerned that retirees since the mid-1990s are going to find that the 4% rule, as it is traditionally defined, will not be sustainable.
In “Will 2000-Era Retirees Experience the Worst Retirement Outcomes in U.S. History? A Progress Report after 10 Years,”I explore the situation facing various hypothetical retirees who retired in different years up to 2000, to see how they are faring 10 years after retirement.
This can be useful, because it turns out that events in the early part of retirement weigh disproportionately on the final retirement outcome. I show, in particular, that the wealth remaining 10 years after retirement combined with the cumulative inflation during those 10 years can explain 80 percent of the variation in a retiree’s maximum sustainable withdrawal rate after 30 years.
It has now been 10 full years for anyone who retired at the start of 2000. And generally, for stock allocations above 50 percent or so, the 2000 retiree has depleted more wealth in nominal terms after 10 years than most any other retiree in history. People who retired at the start of the Great Depression, or just before the stagflation of the 1970s, would still have more wealth after 10 years, and that holds for a variety of assumptions and conditions.
When remaining wealth is considered in real terms after removing the effects of inflation, the situation is not as grim, as the 2000 retiree is in better shape than retirees in the late 1960s and early 1970s. But 10 years after retirement, retirees with less remaining real wealth than the 2000 retiree faced much better market conditions in terms of lower cyclically-adjusted price-earnings ratios, higher dividend yields, and generally higher bond yields.
This leads to the other paper, “Predicting Sustainable Retirement Withdrawal Rates Using Valuation and Yield Measures,”which explores the relationship between retirement withdrawal rates and market valuation levels at the time of retirement.
This study attempts to quantify whether a 4% withdrawal rate can still be considered as safe for U.S. retirees in recent years when earnings valuations have been at historical highs and the dividend yield has been at historical lows. I find that the traditional 4% withdrawal rule is likely to fail for recent retirees. The maximum sustainable withdrawal rate for retirees may continue declining even after the peak in earnings valuations in 2000.
My lowest estimate for a 60/40 allocation between stocks and bonds is 1.46% for new retirees in 2008. The regression framework with variables to predict long-term stock returns, bond returns, and inflation (the components driving the retiree’s remaining portfolio balance) produces estimates that fit the historical data quite well.
The study does have limitations, and in reality I am hopeful that retirees can obtain higher withdrawal rates than I estimate. Retirees with flexibility for their spending can start with a higher rate and keep vigilant about their remaining wealth so they can cut expenditures if the need arises.
Also, including TIPS and international assets could help. Retirees can also consider annuitizing a portion of their wealth at retirement, which with Social Security would help provide a minimum income floor in order to allow for more aggressive withdrawals from non-annuitized wealth.