Sequence of returns and consumption both play a big role in how fast a retirement nest egg is depleted.

When it comes to retirement, the 4% rule just doesn’t cut it for most people. 

That’s according to a new PwC US report that says the notion of withdrawing 4% per year in retirement may work for the wealthy but could be disastrous for everyone else.

If Americans stick to the idea of 4% annual withdrawals — which has been de rigueur since 1994 — they’ll run out of money before they run out of retirement, PwC said. Even the affluent will see their wealth significantly reduced. 

Why is that, when the 4% system seemed to work so well for so long?

According to the report, the theory could actually be based on an anomaly — a period of abnormally high interest rates, although what we’re now experiencing is, of course, considered a period of abnormally low interest rates. 

The paper also suggests that coming up with a new “rule” needs to take into consideration two factors.

The first is the “sequence of returns” risk, which points out that a loss in the value of retirement assets early in retirement will mean that subsequent withdrawals simply dig the hole deeper. 

The second is the “sequence of consumption” risk, which exists during both the accumulation phase of retirement assets and the consumption phase of those same assets. While financing consumption during the accumulation phase carries an opportunity cost to being able to save enough for retirement, the report says, “(m)anaging the sequence of consumption during retirement is even more critical.” 

This is particularly true because of the existence of the “retirement spending smile”: spending in retirement starts out high, falls during the middle period, and then, as retirees age, once again climbs. 

“The body of research that shows most retirees spending much more in their early retirement years than later years is just one example of the way in which retirement realities don’t fit a 4% withdrawal world,” said Elvin Turner, business unit director for research for the Retirement Income Industry Association. 

If consumption is too high during that first high-spending phase, there won’t be enough left to pay for an increase in spending at the other end, when retirees will presumably need it for medical care. 

Then, too, there is the question of longevity. With new life expectancy calculations, it’s no longer valid to assume that retirees will spend about 25 years in retirement. That means that a longer period must be planned for.

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