Wade Pfau: Pandemic Tears Up 4% Rule

In the good old days (before coronavirus), many people could rely on working longer to wrangle a wayward retirement plan back on track. Not anymore. The devastating loss of jobs set off by the COVID-19 pandemic is depriving many folks who planned to retire this year of that lever, as retirement expert Professor Wade Pfau tells ThinkAdvisor in an interview.

Another crushing change: The 4% rule of thumb for income withdrawal in retirement has shriveled to only 2.4% for investors taking “a moderate amount of risk,” according to Pfau’s latest calculations.

The multi-award-winning retirement authority is professor of retirement income and co-director of The New York Life Center for Retirement Income at The American College of Financial Services. Host of the blog Retirement Researcher, the chartered financial analyst holds a doctorate in economics from Princeton University.

In the interview, Pfau stresses that investors typically fall into the “trap” of depending on investment portfolios as the chief way to fund their retirement. Now, many of these folks who are at retirement find themselves needing a life raft.

(Free Webinar on April 16: Stimulus Plan Update: Tax Impact of Early Withdrawals & RMD Waivers)

Acquiring an annuity would have prevented such a dire scenario, he argues, and suggests two types to buy right now to help meet retirement income needs and avoid spending cuts.

For those planning to retire in 2020, he urges to not put off buying an annuity: Because of the steep decrease in interest rates, annuity payment rates have dropped and “could go down further,” he says.

In our conversation, he discusses retirement planning strategies at this chaotic juncture for both the “overfunded” and “underfunded” and two “buffer” assets that can help the latter.

ThinkAdvisor held a phone interview with Pfau, 42, on April 1. He revealed his own early-retirement timetable, which, he says, could now be delayed because of the severe market downturn.

Here are excerpts from our interview:

THINKADVISOR: Suppose an individual or couple were planning to retire this year. In view of the financial damage the pandemic has wrought, what should they be considering now?

WADE PFAU: They need to look at how much it will cost to fund their retirement goals and how much they have. For people who are still overfunded and have sufficient assets, this might be a good wake-up call to take some risk off the table, lock in goals and not expose themselves to [further] market volatility.

What about those who are underfunded?

They may need to look at alternative [techniques], especially if they can’t work for a longer time period. If they have much lower portfolio balances, they may have to scale back some of their expenses temporarily — cut spending now — which can help a lot to manage the risk of what’s happening [in the market]. This will give their portfolio more chance to recover. They won’t necessarily be looking at a permanently lower withdrawal rate.

When it comes to income planning, does the 4% rule of thumb in retirement still apply?

No. The probability that it would work is a lot lower now. It worked in the U.S. historically, but [previous years] never dealt with low interest rates and high stock market valuations at the same time.

What’s the so-called rule now?

I did some updates in mid-March; and for an investor taking a moderate amount of risk, I put out 2.4% as my equivalent of the 4% rule. That’s still about the same today.

It’s roughly half the amount of the traditional rule and means that a typical retiree would need to pull back spending significantly. Ordinarily, they’d have the option to delay retirement by working longer. What about now?

Working longer is the best way to get a retirement plan back on track, but the tragedy of the pandemic is that a lot of people may lose that lever, depending on which sector of the economy their job is in and other factors. However, those who do have the flexibility to continue working might look into it as a way to delay retirement.

You’ve said that during the first 10 years of retirement, market performance drives outcomes. But the market is in terrible shape. Is there a lesson to be learned here?

Yes. The pandemic and resulting market decline make it hard for people who are thinking of retiring this year. This speaks to [trying] not to fall into that trap: It’s a reminder that you can’t necessarily rely on a high rate of return from your investment portfolio as the key way to fund your retirement.

I assume you’re implying that many folks did just that?

Yes. [For example], during the long bull market, people put off getting an annuity: “Maybe I don’t really need an annuity because the stock market keeps going up. So I’ll be fine this way.”