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Retirement Planning > Retirement Investing

Forget the 4% Rule: Planner Explains His Flexible Retirement Withdrawal Strategy

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A common retirement withdrawal strategy involves taking money out at fixed rate — say, 4% a year — or adjusting that rate for inflation. Either way, the results may be uneven and reduce a retiree’s nest egg too quickly, states Jonathan Guyton, a retirement planner and researcher, in an interview by Morningstar’s Christine Benz, director of personal finance, and Jeffrey Ptak, head of global manager research.

A “flexible withdrawal” approach allows a retiree to withdraw funds depending on their needs, as long as they stay within “guardrails,” says Guyton, a certified financial planner and the principal of Cornerstone Wealth Advisors, a fee-only firm in Minneapolis.

In what Benz calls his “seminal” paper — “Decision Rules and Portfolio Management for Retirees: Is the ‘Safe’ Initial Withdrawal Rate Too Safe?” — he established “new guidelines for determining the maximum ‘safe’ initial withdrawal rate, defined as (1) never requiring a reduction in withdrawals from any previous year, (2) allowing for systematic increases to offset inflation, and (3) maintaining the portfolio for at least 40 years,” according to the executive summary.

A constant withdrawal rate becomes problematic as, especially in volatile times like now, the principal can drop. But his research found that, using his strategy, retirees could start at a higher withdrawal rate and adjust it downward when needed.

The example Guyton provides is withdrawing a constant 5% on $1 million in savings, which is $50,000. But what happens when the account drops to $800,000? That 5% withdrawal is now a 6.25% withdrawal, which is too high.

“If you hit that number, that’s a warning, that’s the guardrail and you say, I’m going to take that $50,000 down by 10%,” Guyton explained. “Reduce it to $45,000. And that’s all you need to do for a year. You can measure your withdrawal rate the next day if you want, but what really matters is a year from now. If it’s still under 6%, you’re fine. Keep going, give yourself a raise for inflation. But if it gets back up over 6%, it’s like you hit the guardrail again. You need to adjust it down another 10%.”

During the pandemic, the advisor has not seen the guardrail be hit, as it was during the Great Recession, he told Morningstar.

He notes that 10% reduction in withdrawals isn’t a 10% reduction of spending, something an advisor needs to make clear to their clients.

“Your Social Security didn’t go down, and your pension didn’t go down,” he said. ”Furthermore, that $5,000 of reduced withdrawals, that’s $5,000 that you can reduce from what you’re withdrawing from your IRA or 401(k). In other words, that’s $5,000 that isn’t on your tax return. And so, guess what? Your income taxes are lower. Maybe your income taxes are $1,500 lower. So, that’s not a $5,000 reduction in spending. It’s $3,500 — 300 bucks a month. Will that make a difference? Yes. Will it cause you to have to change your lifestyle? I doubt it.”

Guyton also pointed out that flexibility in spending isn’t new to most people by the time they hit retirement age.

“We know that over the last 40 years they have had variations in their income,” he told Benz and Ptak.  ”[Taking] time off because they have a baby, somebody gets a bonus, somebody takes a leave of absence, somebody gets laid off, there’s an illness. And so, people have 40 years of learning how to be flexible in their spending decision.

“What we realized was that doesn’t go away when you’re 65. That’s the only thing you know how to do. And so, the idea that retirees would have the ability to have some small amount of flexibility in their spending is actually something that lines up with people’s real-life experiences.”

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