The Demise of the 4% "Safe Withdrawal" Rule
By Matthew B. Lowery, Sr, CFP, Managing Director at DFG Private Client
From Print Issue - Spring 2022
When you think about your future, how do you envision your retirement years? For most, retirement is a chance to enjoy doing more of what you want to do. You’ll have more time to travel, or maybe you just want to finally slow down, spending more time with loved ones. Unfortunately, for many busy professionals that fail to plan well, that peaceful vision of retirement will now be tougher to attain. Between the global pandemic, rising inflation, and market volatility that’s (always) just around the corner, it is difficult to determine what your nest egg will look like in 5 years, let alone 30 years from now. One of the biggest concerns we hear from clients is their uncertainty regarding how much money they can expect to safely spend each year once they retire without running out of money. Traditionally, the 4% “safe withdrawal” rule has been used as a rule of thumb, but recent events have called into question how sustainable the 4% rule really is.
WHAT IS THE 4% RULE?
The 4% rule is a retirement income theory about how much money you can safely withdraw from assets each year without running out of money. It became widely publicized after Bill Bengen’s research in 1994, which showed that withdrawing up to 4% of one’s invested assets each year (adjusting annually for inflation) could sustain the typical 30-year retirement. This published research used data going all the way back to 1926.(1)
IS THE 4% RULE OUTDATED?
Recent research suggests that the 4% rule is outdated. Three analysts conducting research at Morningstar concluded that some pertinent historical variables that made Bill Bengen’s conclusion possible no longer apply in our current economic environment.(2)
These factors include:
LOW BOND YIELDS:
Yields on bonds are historically low, at just 1.73% for a 10-year bond as I write this (3), compared to the 15.68% rate in September 1981.(4) Coupled with rising inflation and the expectation that interest rates will also rise, many experts question how today’s bonds can help sustain the traditional 4% withdrawal rate.
HIGH STOCK VALUATIONS:
Stock valuations are historically high, and many experts don’t understand the phenomenon. You’re probably thinking about “meme stocks” you’ve seen on the news that just seem to unexplainably trade higher, like it’s a popularity contest to own them. Yet, some of these companies’ financials look like they are the “walking dead” because they have so much debt. We call these companies “zombies”, and they are ones to avoid owning.
WAYS TO PROTECT YOUR RETIREMENT INCOME SUSTAINABILITY AND GET MORE
There are things you can do to better protect yourself from market uncertainty, and in the process create even higher sustainable retirement income.
CONSIDER ADDING A “VOLATILITY BUFFER” ASSET
One smart option to consider is to fund a cash value life insurance policy as a safe complement to your market holdings at-risk. Adding this instrument as a “2nd Economic Power” (the power of actuarial science) will rev up the horsepower behind your retirement income plan. During the “accumulation years” of life, most people solely use capital markets investing, and that is generally inefficient by comparison to a “combination approach” in terms of both income sustainability and the actual amount of retirement income you’ll have. Let’s examine. Cash value life insurance can be guaranteed to grow. The cash inside your policy is not exposed to downside risks that affect your other assets (i.e., stocks and bonds).(6) Therefore, this cash can act as a type of supplemental emergency fund that can be used for entire years’ worth of your expenses during (or just after) market downturns while you let your (at-risk) investments recover. This approach can both substantially help your level of retirement income and keep it more sustainable.
CONSIDER GUARANTEED INCOME SOURCES
Another way to protect your retirement assets from market fluctuation is by considering other guaranteed income sources available to you. These sources include:
For maximum longevity protection and amount of income, consider delaying your Social Security income until age 70 to obtain the latest delay credit.
While not available to most people, pension income is another source of guaranteed retirement funding that can be in the form of a lump sum at retirement, or a stream of lifetime payments — with or without rights of survivorship if you have a spouse.
CREATING LIFETIME ANNUITY INCOME
An annuity is a type of insurance product for which you trade accumulated assets for a guaranteed stream of income to begin now or in the future. Many annuities offer income payments guaranteed for life, which ensures you will not outlive your retirement funds no matter how the future markets perform.
TAKE ACTION TO POSITIVELY IMPACT YOUR FUTURE
The more you can rely on alternative and/or other sources of retirement income as a complement to your traditional investment portfolio, the less you will have to rely on the ups and downs of the market in the future. Regardless of whether the 4% rule is dead, it’s important to make sure you plan your future income well so your retirement funds will sustain your lifestyle needs.