Retirement Rules: Rethinking a 4% Withdrawal Rate

via Barron’s

Figuring out how to convert a nest egg into enough income to fund a comfortable retirement without completely draining savings is perhaps the biggest issue facing retirees and financial advisors. Wade Pfau, a soft-spoken, Princeton University-trained economist, has taken on the task of trying to solve the puzzle.

Pfau, 37, spent the first decade of his career teaching economics to bureaucrats from emerging markets at the National Graduate Institute of Policy Studies in Tokyo. But he has long had an interest in retirement, going back to his doctoral thesis, which focused on President George W. Bush’s Social Security reform proposal. Pfau came into the limelight in 2010 with a paper that poked holes in the 4% rule long used in financial planning to help retirees spend a nest egg judiciously. After data showed that the rule, which posits the withdrawal of 4% of a portfolio in the first year of retirement, with annual adjustments for inflation thereafter, had worked in only two of 20 developed countries — the U.S. and Canada — Pfau dug deeper. He found that the rule wouldn’t work in a number of circumstances, including retiring during a market downturn and in a period of historically low interest rates.

Barron’s: The 4% rule was first introduced in 1994 by financial advisor Bill Bengen, and quickly became conventional wisdom. What’s wrong with it?

Wade Pfau: Where to begin.…It’s not always appropriate. The rule suggests that if retirees withdraw 4% of their portfolio in their first year of retirement, and adjust that initial amount for inflation in subsequent years, they’ll have a low risk of depleting their portfolio in 30 years. In 1994, a 30-year retirement was a conservative assumption — retiring at 65 or even 55 and living another 30 years was well beyond average life spans. But today, there is a 50% chance that one member of a higher-income, 65-year-old couple will live until 95…

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Eric is a Producer at Lockton Insurance Brokers, Inc., the world’s largest privately held commercial broker. Eric has over 23 years of experience in the insurance industry and has spent the last 11 years with Lockton. Eric specializes in Health & Welfare Benefits, Retirement Planning, and Executive Benefits. Eric's clients utilize his expertise in the areas of Plan Due Diligence, Transaction Structure, Fiduciary Oversight, Investment Design, Compliance and Vendor negotiation to improve the operational & financial outcome for each client. The Benefit Blog is a place to share that expertise and industry news.
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