Why Your Retirement Plan Will Fail: Part Four

Unfortunately, most articles out in the media today focus on a few financial topics; reducing spending/budgeting, paying down debt, buying a house and investing in low cost index funds. While all these topics are important there is one aspect of financial planning that is rarely discussed; describing what retirement is actually like.

Over the next month or so, we are going to take a deep dive into describing retirement from a financial perspective. We are going to look at what risks can derail a retirement and how to create a plan to mitigate those risks. Click the links for Parts One, Two and Three. Let’s continue with the series and discuss withdrawal rates.

Withdrawal rates correlate to one consistent fear for retirees; running out of money. For those that are nearing retirement, they may have heard of something called the 4% rule. The 4% rule came in to play after an advisor named William Bengen conducted a study of “safe” withdrawal rates in 1994. He looked back at historical returns starting in the 1930s and found that no portfolio ran out of money over a 33-year period if a person withdrew 4% of their portfolio per year. At the time, 4% was considered a “safe” withdrawal rate. Is that still the case?

Before we answer the question, let’s take a step back. Currently, most people in retirement will derive their income from two sources; Social Security and assets that they saved (such as in a 401k). Social Security payments will continue to come in each month regardless of what happens in the market. A retiree’s assets are still usually subject to the market as we discussed in Part One. Since Social Security payments will replace about 40%* of a retiree’s pre-retirement earnings, that puts a lot of pressure on the retiree’s assets.

Getting back to the withdrawal rate question, is the 4% withdrawal rate still safe. Honestly, the answer depends on a variety of factors. One reason to look at the 4% rule with a grain of salt is interest rates back in the 60’s through the 80’s were much higher than they are now. A retirement portfolio that contained bonds back then would produce a greater rate of return compared to today. Some will argue that 3.5% is a much “safer” withdrawal rate. We also must factor in a person’s lifestyle, the type of asset mix and whether a retiree has other guaranteed income sources such as a pension or an annuity.

Retiring successfully does take some planning. Understanding if you’re on track or not should take some reflection, but if you’re looking to see how much money your assets could generate multiply that number by 3% or 3.5%. If that number is too low, you may need to look at saving more, evaluating other income sources or finding ways to reduce expenses. When reviewing expenses be sure to account for larger ticket items such as home repairs, new cars or health care expenses.

*Source: https://www.ssa.gov/planners/retire/r&m6.html