At a recent financial advisors’ conference in California, one of the biggest topics of discussion involved the optimal savings withdrawal rates for retirees.
Almost 20 years ago, certified financial planner William Bengen posted a series of papers on sustainable withdrawal rates. Based on historical reconstruction of retirees’ portfolios since 1926 (with respect to asset class returns as well as inflation), these papers recommended a 4 percent withdrawal rate for the first year, followed by cost of living adjustments every succeeding year.
Years later, by adding asset classes to his analysis, Bengen increased the withdrawal rate to 4.5 percent. Recently, others have expressed concerns that due to stock market returns from 2000, the 4.5 percent rule must be reduced.
When Bengen conducted his first research in 1993, only 38 complete 30-year retirement periods were available for study. Today, there are 57. He believes no sample would provide conclusive results, because markets change over time. However, Bengen maintains that the 87 years beginning in 1926 saw a wide range of market and economic conditions, including wars, depressions, oil shocks, etc. Employing the 4.5 percent initial withdrawal rate, he studied the 57 retirement periods and determined that only those people who retired January 1, 1969, would have exhausted their savings at the end of 30 years.
According to Bengen, research has confirmed the “sequence of investment returns” is crucial for portfolio longevity. A retiree with low returns early in retirement will probably have trouble later in retirement.
What is often overlooked is the inflation rate. High inflation early in retirement can result in rapid escalation of withdrawals and depletion of the portfolio. That is what happened to the 1969 retiree. Inflation rates from 1969 to 1980 averaged almost 8 percent per year. Bengen’s analysis showed the 1969 retiree’s withdrawal rate almost tripled from 4.5 to 12.5 percent during the first 12 years of retirement. A 12.5 percent initial withdrawal rate is normally associated with a portfolio designed to last only about seven years. However, it lasted an additional 18 years due to the bull market that began in 1982.
In contrast, a 2000 retiree saw his or her withdrawal rate climb relatively modestly, from 4.5 to 5.9 percent within 12 years. Bengen believes that the 2000 retiree has a “fighting chance” of sustaining at least 30 years of withdrawals from the portfolio, although that portfolio may shrink in value over time.
Bengen is not ready to abandon the 4.5 percent rule for his clients. However, considering the growing uncertainties we face in the future, he advises considering strategies for dealing with a possible future failure of the 4.5 percent rate.
Retirement withdrawal plans do not have to be static—they can be modified at any time. The two essential ways to deal with retirement spending problems are either to increase income or reduce expenses.
Bengen offers the following rule for your consideration: Take some pre-emptive action, no matter how mild, when the withdrawal rate first exceeds the initial rate by 25 percent. If withdrawal rates continue to rise, take more aggressive action. While he still believes the 4.5 percent rule appears valid, retirees should remember it may not remain so in the future.