A 4% retirement asset withdrawal rate remains the standard for financial planning, but it doesn’t hold up against every scenario.
In fact, according to a new white paper, longevity, volatility and inflation are putting pressure on the usefulness of the 4% rule for retirement distributions.
The paper, which was released by the Alliance for Lifetime Income, an insurance and industry trade group, is called “Planning for Retirement Income Within an Increasingly Volatile and Uncertain World,” and it revisits common retirement planning income assumptions. The paper was written by Colin Devine, an education fellow for the alliance and a principal at Devine & Associates, and Ken Mungan, the chairman of alliance member Milliman, an independent provider of actuarial and risk management services.
“The results provided by our research and models present substantial cause for concern, particularly within a world where increasing volatility has arguably become the norm,” Devine and Mungan write.
In conducting their own research on a safe retirement withdrawal rate, the authors found that the 4% rate, under normal conditions, still holds strong, and it poses only a small 16% risk that retirees will run out of assets within the first 20 years of retirement.
The 16% failure rate was an average of three different portfolio assumptions: equity-to-bond allocation mixes of 60% to 40%, of 70% to 30%, or 80% to 20%. The authors assumed the inflation rate was 2%.
The authors also studied a 5% withdrawal rate and found that a retiree using this rule of thumb faced twice the risk of exhausting assets than they would have using the 4% rule.
The paper then looked to a 6% rate, approximating the payout factor of a single-premium immediate annuity. Retirees using 6% portfolio withdrawals ran a 60% chance of running out of income within the first 20 years in a 60%-40% portfolio.
Devine and Munger extended the 4% findings beyond the 20-year point in retirement and found some fragility in the rule. In each portfolio allocation assumption, the failure rate of the 4% rule crossed the 50% threshold somewhere between a person’s 30th and 40th year of retirement.
It’s not enough for advisors to look at a person’s average life expectancy, say the authors, since “half of the population could be expected to exceed it, particularly as the standard deviation for longevity is about 10 years. Extending the time horizon out to 25, 30, 35 or even 40 years suggests that for each of these time periods there is simply much too high a risk of outliving income.”