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Retirement Planning > Spending in Retirement

Why It’s Time to Drop the ‘Set It & Forget It’ 4% Rule

By John Manganaro

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What You Need to Know

  • Experts say the decumulation challenge represents one of the biggest opportunities for advisors who want to deliver exceptional value to their clients.
  • Researchers say flexible spending strategies deliver the best outcomes, but they aren’t easy to build.
  • One jumping-off point is the emerging concept of the retirement spending smile.

Older Americans preparing for the move from work to retirement face a big challenge: How can they enjoy the fruits of their labor while making sure they spend at a sustainable level?

Research finds the most popular spending frameworks, such as the 4% rule, are about as likely to cause overspending as they are to cause underspending for any given retiree. Plus, popular spending rules often fail to account for changes in lifestyle experienced by nearly all retirees as they age and navigate the latter stages of life. 

This “decumulation challenge” represents one of the biggest opportunities for financial professionals who want to deliver exceptional value to their clients, according to Mark Berg, founder of and lead advisor at Timothy Financial Counsel.

Helping clients answer the spending question is part art and part science, says Berg, who was featured last week in Morningstar’s The Long View podcast, hosted by Christine Benz and Jeff Ptak. 

During the discussion, Berg dug into the emerging concept of the “retirement spending smile,” popularized by the researcher David Blanchett. Berg also  encouraged other advisors to avoid “set it and forget it” income planning.

According to Berg, Benz and Ptak, advisors can help their clients make the most of retirement by embracing more flexible spending strategies that more accurately reflect peoples’ lives in their later years. This would allow clients to adjust their spending over time in a way that supports lifestyle goals while also keeping the risk of running out of money at bay.

Nuts and Bolts

In Berg’s experience, the start of any spending strategy is to identify what level of guaranteed fixed income a client will have coming in from sources such as Social Security or a pension. This income base can then be compared with the client’s lifestyle, their portfolio mix and their blend of pre-tax and post-tax wealth.

According to Berg, many retirees who have the means and wherewithal to engage with financial advisors are actually in a better position than they anticipate, meaning they may significantly underestimate their personalized sustainable spending rate.

“We are finding that we are typically doing more to encourage spending than we are to discourage spending,” Berg says. “Many people come to us living so well within their means that their actual withdrawal rate is only 1%, 2% or 3%. They could be spending more.”

When advisors run the numbers, Berg explains, a 4% to 5% annual withdrawal range tends to be sustainable, especially if the plan is consistently monitored and cuts in spending are made if there’s a bad year or two in the markets.

This level of spending often means clients early in retirement can take trips and make purchases they’ve dreamed about. In many cases, advisors can help such clients spend confidently by implementing (and repeatedly stress testing) a dynamic spending strategy with pre-defined floors and ceilings.

“In practice, the time in the 60s and 70s is the sweet spot when people still have their health, and this affords them the ability to travel and really enjoy life,” Berg says. “One couple always comes to mind for me. … They took their first trip, came back, and they were different people. It’s been a joy each year as we set a budget for enjoying a lifetime of earning.”

The Spending Smile

Berg says his practical experience serving clients has given him a great deal of perspective about how lifestyles and spending patterns evolve during retirement. This experience, he adds, is also reflected in the findings of research into the “retirement spending smile.”

Simply put, real-world data shows average spending in retirement starts out higher as people remain active and engaged. Then spending tends to fall during the middle period of retirement, as people see their health decline and their lifestyle interest shift away from travel and big purchases.

Lastly, as retirees age and they face more intense healthcare needs and require support with daily living, spending once again climbs, representing the other side of the spending “smile.” Throughout this journey, Berg notes, spending also generally shifts across categories, with less money being spent on things like vacations and big-ticket purchases later in life.

While not universally true, Berg adds, medical costs tend to rise in the middle and late retirement periods, but this increase is often blunted by support coming from Medicare and other forms of insurance.

“We have also definitely seen that expenses vary by individuals’ circumstance,” Berg says. “Overall, it goes to show that income is a very dynamic issue that needs to be managed and constantly revisited.”

Risk & Insurance

In Berg’s experience, it’s also important to factor in client perspectives about different forms of insurance during the planning process, including consideration of guaranteed income annuities and long-term care insurance.

In many cases, he explains, the math shows that the purchase of annuities or long-term care insurance makes a lot of sense from a purely financial perspective, but behavioral issues can be a hurdle to optimal planning.

“Some people avoid insurance at all costs,” Berg states. “Other people are very, very comfortable and see it as a great tool to manage the fears or concerns that they have. So, as we’ve been saying all along, financial planning is not one-size-fits-all. You really have to customize it to that client and their specific circumstance and their mentality.”

(Image: Shutterstock)

John Manganaro

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