Nearly 30 years ago, financial advisor William Bengen conceived the so-called 4% rule as a guardrail for retirement budgeting. In essence, it holds that people can fund their retirement adequately by withdrawing or consuming 4% of their financial assets annually, increasing it periodically for inflation.
Over the years, Bengen himself tweaked his own guidance. In worst case scenarios, retirees can actually withdraw 4.7%, the now retired Bengen says. Adding small-cap stocks to a portfolio of intermediate-term Treasurys and large-cap stocks can help enhance returns.
Not all advisors agree. As the price of stocks and bonds climbed over the last decade, the income that these financial assets produced declined on a per dollar basis.
Some advisors and academics saw this altered economic environment as a valid reason to advise retirees to slash their asset consumption rate to 3%, in case returns regressed to the historic mean. Few of them were even thinking about a resurgence in inflation.
Mixed Reviews
Few advisors, Bengen included, believe the rule should be set in stone. “While the 4% rule doesn’t really need revising, I’ve been saying since 2004 that a flexible withdrawal approach is best and most realistic,” says Jonathan Guyton, a financial planner and principal at Cornerstone Wealth Advisors in Edina, Minn., who has extensively studied the issue,
Retirees with a solid, evidence-based plan and an advisor to keep them on track, Guyton adds, can manage to live within the 4% spending limit. Retirees “are doing just fine these days even as markets fluctuate,” he argues.
But Bob Kalman, founder and senior portfolio manager at Miramar Capital in Northbrook, Ill., disagrees. “The 4% rule does need modification for several reasons,” he says, citing rising interest rates and stock market returns that were unusually high until 2022. The rule, he says, “presupposes factors that aren’t applicable in today’s environment.”
The Case Against The 4% Rule
For some, the 4% rule is intrinsically flawed.
“The whole thesis for a ‘safe’ 4% income rule is based on backward-looking data,” says Philip Chao, founder and CIO of Experiential Wealth in Cabin John, Md. “Assumptions that worked for the past may and often do not work exactly going forward.”
Marissa Beyer of Fidato Wealth in Middleburg Heights, Ohio, puts it another way. “What happens if the stock market has a great one-to-two-year period and the account balance goes up—does the distribution amount get recalculated?” she asks. “What if the opposite happens, and the account value goes down?”
The rule also doesn’t account for unexpected expenses, she says, such as healthcare emergencies, troubled grandchildren or “bucket-list trips.”
The 4% Stalwarts
Yet others stand by the old standard. Indeed, research conducted by Bengen, Michael Kitces and others found that the rule held up for people who retired at just the wrong time and confronted a potential sequence-of returns shortfall.
Put simply, the sequence-of-returns challenge occurs when someone retires at the start of a bear market for stocks and bonds or a bout of inflation. All three conditions prevailed in the late 1960s which began an extended decade of high inflation and weak equity returns that combined to ravage Americans’ wealth. Multiple sttudies show the 4% rule still worked.
“The 4% rule doesn’t need revision insomuch as it serves as a useful guideline,” says John E. Roessler, senior financial planner at Kovitz, a wealth management firm in Chicago. It is, he says, a sustainable rate even if you retire at “the worst moment.”
Roessler calls it “a very conservative withdrawal rate” and, therefore, appropriate for today’s volatile market.
Retirement Spending Is Clients’ Top Concern
For clients, understanding how much they can safely spend in retirement without going broke is the top reason they seek professional financial guidance, according to a recent survey by the American College of Financial Services’ Granum Center for Financial Security.
Unlike our working years, retirement is “more about preserving assets than growing them,” says Christopher Briscoe, vice president and wealth advisor at Girard, a Univest Wealth Division, in King of Prussia, Pa. “You want to find an allocation that helps you achieve your goals without taking on unnecessary risk.”
Advisors need to provide clients with a reality check, taking into account all their retirement income sources—401(k)s and other retirement accounts, Social Security, possibly real estate—as well as reasonable expense estimates.
Age Matters
One key metric is how long the money needs to last. A 50-year-old retiree can reasonably expect to need funds longer than a 70-year-old retiree.
“Always calibrate the withdrawal estimate to the individual situation,” says David Blanchett, head of retirement research at PGIM, the Newark, N.J.-based asset management arm of Prudential Financial. He suggests adding five years to the retiree’s life expectancy, just in case.
But beyond that basic withdrawal rate, he says, flexibility is “really important. If you don’t have any flexibility around spending, then the initial withdrawal rate has to be low.”
Ultimately, says Blanchett, “The more flexible you can be, the more you can spend.”
Flexibility, Within Limits
A degree of flexibility certainly seems wise. Clayton Quamme, partner and financial advisor at AP Wealth Management in Augusta, Ga., points out that retirees tend to spend more in the early years of retirement as they travel and otherwise enjoy their new freedom. They spend less in the middle stage and then more again later as medical expenses increase.
“If you understand this, you can effectively plan your retirement to maximize each phase and not run out of money,” he says.
To manage such changes wisely, he suggests setting “guardrails” to minimize risks. “Each client’s guardrails will be different,” says Quamme, “based on their mix of retirement income sources and the flexibility in their expenses.”
Other Sources Of Retirement Income
Retirement income can come from any number of sources, of course. Mallon FitzPatrick, managing director and principal at Robertson Stephens Wealth Management in New York, recommends combining withdrawals from taxable accounts, tax-deferred accounts such as IRAs, and nontaxable accounts such as Roth IRAs “to keep taxable income in the lower tax brackets,” he says.
Many retirees, he adds, continue working part time, too, for as long as they can. Others rent space in their homes for extra income.
Home Equity
Home equity is another potential source of funds in retirement—if managed carefully.
“I am not a proponent of borrowing against home equity in retirement to satisfy living expenses, but in many cases, when clients sell their homes and relocate, they downsize,” says Michael Green, senior wealth advisor and vice president of Parsippany Private Client Services in Parsippany, N.J., part of the West Hartford, Conn.-based GYL Financial Synergies. “This frees up funds that [clients] often overlook.”
For short-term cash flow shortfalls, clients might choose viable alternatives, such as taking out a reverse mortgage or claiming the cash value of a life insurance policy. Wade Pfau, a professor of retirement income at the American College of Financial Services in King of Prussia, Pa., and author of the Retirement Planning Guidebook, calls these “buffer assets that can serve as temporary spending resources to give an investment portfolio more opportunity to recover after a market downturn.”
But such resources must be used strategically, particularly reverse mortgages. The concept of hocking one’s home elicits aversion among many retirees. “The last thing you want is to be booted out of your home,” says Charles Lewis Sizemore of Sizemore Capital Management in Dallas.
Annuities
Annuities can also provide income stability, but again, one must be cautious. “I generally dislike the inevitable loss of control you have when you buy an annuity,” says Sizemore, “but there are times when the additional income above the yield on a bond portfolio makes them worth considering.”
Theodore E. Saade, managing senior partner at Signature Estate & Investment Advisors in Los Angeles, might agree. “As fiduciaries, it’s essential to present such products to clients where appropriate,” he says, adding, “The annuity industry continues to evolve and has come out with offerings” that are often appropriate.
The Unknowns
It’s also a good idea to be mindful of how far a dollar will or will not go. “Considering how inflation will affect [client] spending, especially in later years of retirement, is an integral part of easing a client’s concerns,” says Ken Van Leeuwen, CEO and founder of Van Leeuwen and Co. in Princeton, N.J.
Given so many unknowns, perhaps the very idea of a “withdrawal rule” is nonsensical. “It’s hard to make a one-size-fits-all rule,” says Justin Dime, associate wealth advisor at Bordeaux Wealth Advisors in Menlo Park, Calif. “You need to be creative and flexible, depending on the situation.”