After 25 years, the 4 percent rule for retirement withdrawals is still a useful guide for advisors—but it could be made better.
That’s the opinion of Michael LaBrie, founder, owner and advisor at Wakefield, Mass.-based Compass Point Retirement Planning, whose “Tru Method” for estimating retirement withdrawals purports to offer a more accurate picture of potential retirement income over time.
“There’s more than one way to fail,” says LaBrie. “Most people only understand one failure, running out of money, but setting a person on a path to withdraw far less than they want or need is also a problem. You can maximize what retirees live on, enable them to leave a legacy and whatever else they may want, but you only have one chance to get it right.”
An Ingenious Start
The 4 percent rule, developed by financial advisor William Bengen in 1994 (when it was actually called the 4.5 percent rule), is often used by those planning for retirement to estimate how much retirees can afford to spend, or how much pre-retirees need to save, to enjoy a comfortable and sustainable retirement. At the time of retirement, the clients’ assets are totaled, and then 4 percent is assumed to be a “safe” withdrawal rate that will not deplete the portfolio before a full 30-year retirement is completed.
As LaBrie sees it, the more central issue is determining the largest withdrawal the clients can comfortably take during retirement, rather than figuring out how much they need to save. Usually by the time an advisor is working with them, clients’ ability to save more is constrained by time or retirement—or both.
“I consider myself an income engineer,” LaBrie says. “People are coming to me to make sure they don’t run out of money and that they live the best life they can—those are often counter-objectives.”
The more retirees take, the less safe they become, but on the other hand, the safer a retiree’s income stream, the less income he or she will take. This relationship between income and portfolio success is already well known to retirement planners.
LaBrie argues that it is often impractical to recommend that clients reduce their cost of living: Unlike wealthy clients, the less wealthy already face a concern that they will deplete their portfolios, which means they’re likely unable to place additional constraints on their lifestyles.
That doesn’t mean the 4 percent rule can’t be used by certain people, says LaBrie, but it only works at certain points in time.