The persistent—and futile—debate over the 4% rule for retirement income brings to mind the observation of the American social critic H.L. Mencken:
“There is always a well-known solution to every human problem—neat, plausible and wrong,” he wrote in 1920.
Retirement wasn’t on Mencken’s mind (the average life expectancy in 1920 was around 54). But I imagine he might have anticipated the 4% rule—or perhaps the zombie economic theory that tax cuts pay for themselves. Both are neat, plausible and not obviously wrong.
The 4% rule works as a back-of-the-napkin analysis of how much an investor or couple can withdraw annually to stretch their savings to last about 30 years. Clients want to know how to transform their accumulated savings into a retirement income stream. But the 4% rule fails to fit with the nuanced, personalized, tax-aware and technology-informed approach you want to take with those clients.
When 4% Works—And (More Often) When It Doesn’t
The 4% rule suggests that people retiring between the ages of 60 and 65 can withdraw 4% of their accumulated savings (invested 50% in stocks and 50% in bonds) to pay expenses in year one. Each year after, they can withdraw the same amount plus a cost-of-living adjustment based on the inflation rate.
I can think of one type of case that supports a “withdrawal rule”: when it’s a single retired person with safe investments and consistent Social Security, pension or annuity payments. A withdrawal level could be assigned based on the rate available from a single-payment income annuity with the cost-of-living adjustment.
But the case for a constant withdrawal level falls apart when it comes to married couples. At some point, one spouse will die, while the other will be widowed. Suddenly, the survivor will receive smaller payments from Social Security or perhaps pensions. This won’t necessarily be the partner with fewer health concerns or superior financial skills. Later, widowed partners will face higher tax rates because their deductions and tax brackets are sliced in half after they file as a single person. They may also need to contend with the still-emerging rules on required minimum distributions (RMDs).
This means married couples should likely be reducing their annual withdrawal level when they begin retirement—in order to prepare for the period later when the aging survivor must increase withdrawals to maintain a home and lifestyle and possibly in-home or facility services.
Regular Meetings
You’re going to have to meet with your clients regularly, because figuring out appropriate withdrawal levels is an ongoing process. The amounts will actually vary over the course of their retirement and depend on a few factors:
• Whether the couple have both stopped working or whether they work part time;
• Whether they receive unpredicted windfalls in the form of bequests or gifts; and
• When they begin collecting Social Security and start their RMDs.
For example, it can make sense for some 65-ish retirees to take larger withdrawals from brokerage and savings accounts. This allows them to:
• Defer collecting Social Security until age 70;
• Wait to draw from retirement accounts until it’s mandated; and
• Allow those accounts to continue to benefit from interest accruing and investment gains.
It’s worth noting that the economy and the markets can throw a wrench into the best laid plans retirees have for regular withdrawals at any percentage. For example, in the past few years, people who committed to a level of withdrawal may have struggled to pay drastically higher costs for food, housing, fuel and other basic living expenses.
Samuelson’s Formula
I’ve made my point: A tidy solution ignores the caprices of life and the inherent complexity of retirement income management.
Nevertheless, I will defy H.L. Mencken’s warning about neat solutions with a few of my own, strategies that offer wise savers a high batting average for success:
• Healthy individuals should put off filing for Social Security until they are 70. Advisors can help them with ideas about how to do this. By delaying, they will collect significantly more in Social Security benefits over their lifetimes.
• Healthy individuals should also work as long as they can to shore up their savings and capacity to meet their needs when they’ve reached more advanced ages.
• As households transition into retirement, they can take higher account withdrawals while they wait for retirement income from Social Security and the required distributions from their retirement plans to partially replace earned income.
• Households with tax-advantaged retirement accounts—IRAs, 401(k)s and the like—as well as taxable brokerage accounts can reduce their expected lifetime taxes on IRA withdrawals by aiming to achieve a constant taxable income (corrected for the retirees’ marital status).
• Households with small investment accounts should buy at least one income annuity with survivor benefits but without a long period of guaranteed payments. This will provide a low-cost, reliable retirement income stream and peace of mind.
• Married people should understand all the household investments and retirement income sources they and their spouses hold, because one of the spouses will eventually have to carry on alone. As an advisor, you can help with that. If there is a reliable child or other trustworthy relative, they should be included in the conversations.
Get ready. This year marks “Peak 65,” when more boomers turn 65 than in any year past. Retirement is on their minds: In Allianz Life’s recent “2023 New Year’s Resolutions Survey,” more than one in five workers said they would likely retire in 2024. Among boomers still working, 31% said they would likely retire in 2024.
The work of accumulating assets can seem easy when compared with the work of unwinding them. But your advice is as necessary as ever. Please don’t fall victim to the notion that any of it is neat.
Paul R. Samuelson is the chief investment officer and co-founder of LifeYield.