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Retirement Planning > Retirement Investing

Time to Retire the 4% Rule, Retirement Pros Say

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What You Need to Know

  • The 4% withdrawal rule is about as likely to cause over-spending as it is to cause under-spending for any given retiree.
  • Developments in the annuity marketplace are important for advisors and clients to understand.
  • The broad move away from commission-based business towards fee-based fiduciary advisory work is also helping to remake the income landscape.

Three experienced retirement industry professionals sat down with a handful of journalists Wednesday in New York for a roundtable discussion about an oft-debated, timeless topic in the world of financial planning: the 4% withdrawal rule.

The speakers included David Lau, founder and CEO of DPL Financial Partners; David Blanchett, managing director, head of retirement research, PGIM DC Solutions; and Shannon Stone, lead wealth advisor at Griffin Black Inc.

At a high level, their trio agreed that the 4% withdrawal rule represents one of the most misunderstood and misinterpreted pieces of common wisdom in the world of financial planning.

As Blanchett points out, the rule itself is merely a mathematical framework that suggests a given individual in retirement should add up all of their investments and simply plan to withdraw 4% of their total wealth during their first year of retirement, with the withdrawal amount then being adjusted annually to account for inflation.

“When the rule was first put forward it represented a novel and interesting analysis,” Blanchett says. “It demonstrated that a retirement strategy with 50% in U.S. stocks and 50% in government bonds would have survived each 30-year period in the U.S. historical record from 1926 to 1991 — so long as the asset owner withdrawals no more than 4% per annum during that period.”

That is a very useful piece of information to know, Lau says, but it is not a “retirement income plan.”

“Our criticism today is not about the research itself or the methodology— it’s about the application,” Lau says. “Simply put, the 4% withdrawal rule was never meant to be a real retirement plan. It is meant to be a guideline for the use of a portion of your retirement assets – the 401(k) plan or individual retirement account. Far too many advisors and clients are using this as their income plan.”

As Stone emphasizes, in the real world, retirement income planning is scary for clients who have spent a working lifetime accumulating assets and watching their account balances grow. It makes sense that they would gravitate towards an easily digestible rule of thumb that promises a measure of safety, even if the rule is not of much use in practice.

The trio suggests advisors often gravitate to the rule for this same reason — the projection or idea of safety.

“The rule gives advisors an easy way to speak with their clients about the market roller coaster they are likely to experience during their retirement period,” Blanchett says. “It’s a great way for advisors to project a feeling of security onto a strategy built upon investments that carry inherent risk.”

According to Lau, Stone and Blanchett, the 4% withdrawal rule is about as likely to cause over-spending as it is to cause under-spending for any given retiree. The real sustainable spending level will depend on a myriad of factors, from the sequence of market returns to the anticipated retirement lifestyle.

The trio agrees that addressing a clients’ tolerance for income risk and their desire for safety needs to start well before retirement begins — with planning that takes into account both their financial and emotional needs. Something like the 4% rule, which relies on full market participation with no annuitization of assets, may very well work for a client that has excess assets and a strong stomach for risk.

“For clients who have sufficient assets and who can handle the market volatility without making trading mistakes based on fear or emotion, a probabilities-based total return strategy that draws retirement income directly from the portfolio may be the right approach,” Blanchett says.

On the other hand, for those who are uncomfortable riding out the markets, incorporating a guaranteed income component into the overall plan in the form of an annuity can help alleviate many of the fears clients express.

“This is going to be far more productive to a retirement income plan compared with just seeing the person move to cash,” Lau emphasizes.

According to Stone, Lau and Blanchett, recent developments in the annuity marketplace have completely reshaped the solution set that is available to advisors and their clients. While traditional single premium immediate annuities, or “SPIAs,” continue to generate income through true annuitization, it is now far more common for income to be generated through riders.

This means that many annuities products have far more flexibility than advisors and clients often assume, Lau says.

“This is important because clients are not turning over assets to the insurance company to generate income,” Lau explains. “When income is generated using a rider, cash value remains in the portfolio until it is depleted through distributions.”

Stone says this development is incredibly important for advisors to understand, because it addresses the most common point of hesitancy clients cite when refusing to consider annuities as part of their retirement income planning efforts. Additionally, Stone says, the broad move away from commission-based business towards fee-based fiduciary advisory work is also helping to remake the income landscape.

All in all, the panelists agree, it is time to retire the 4% withdrawal rule as an income plan. The data will remain useful, they agree, but advisors have to step up their game.


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