The 'Tiresome' Persistence of the 4% Rule

Moshe Milevsky

Another important warning for clients to hear is that people today tend to live much longer in retirement than they did 30 years ago when the 4% rule was first tabulated, and empirical data shows retirement spending fluctuates a lot based on people’s real-world needs.

Still, the 4% rule remains ubiquitous, and it is even recommended by some financial advisors.

Such advisors may be steering their clients toward the dreaded retirement income death spiral, which is the inevitable result of at-risk clients failing to carefully monitor the effect of annual spending or market drops on their overall financial plan. Advisors who use the 4% rule might also be causing some clients to significantly underspend.

Why Rules of Thumb Resonate

The news article chided by Milevsky doesn’t cover new ground, but it does provide an important reminder about what is a reasonable starting point for portfolio withdrawals and what is not, according to David Blanchett, managing director and head of retirement research for PGIM DC Solutions.

“If you look at the landscape of research and pundits around a safe initial portfolio withdrawal rate, you can see anywhere from 2% to 8%, with 4%-ish tending to be where most people end up,” Blanchett said.

“I think that’s probably a little low, where 5% is probably more accurate when you incorporate concepts like retirees have some flexibility when it comes to spending and almost all retirees have some existing guaranteed lifetime income,” Blanchett added. Even those without a pension or annuities can expect to rely on Social Security, for example.

Ultimately, Blanchett said he likes “rules of thumb that are reasonable, not sensationalized.”

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“While this doesn’t necessarily cover new ground, that doesn’t mean reminders can’t be useful, especially since most financial planning software is based on an analysis very similar to what’s in the piece,” Blanchett said.

Leaving Money on the Table

Another important factor to point out about the news article is the time period and market conditions considered, according to Michael Finke, the professor and Frank M. Engle Chair of Economic Security at the American College of Financial Services.

“The article highlights one of the two periods during the 2000s where new retirees got hammered with a poor sequence of investment returns,” Finke pointed out. “It also makes the important point that following the 4% rule would leave an investor with about $400,000 of their original $1 million.”

If a person retired at 65 in 2000, as is the case in the news article, that means they’re now around  89 years old, spending $75,000 a year after inflation adjustments from a portfolio of $400,000.

“The article makes it appear that spending 5% or 6% of your balance at the beginning of retirement is far too risky. I disagree,” Finke said. “I think the bigger risk is failing to spend the money when you can enjoy it the most, and then continuing to maintain the same after-inflation lifestyle when you’re less likely to be going on European vacations or buying a new convertible.”

The article also ignores the fact that a client can spend more if they take a portion of their bond portfolio and buy an income annuity to reduce longevity risk, Finke said.

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“Most retirement experts agree that the fixed spending strategy is outdated and doesn’t match how people spend money in retirement,” he said.

Pictured: Moshe Milevsky