- 4-Minute Article
- Oct 20, 2017
Is the 4% Rule Still Relevant in your Conversations with Clients?
Learn whether the rule is still valid or if you should be working with a different figure.
The 4% withdrawal rule has been around since 1994 when financial advisor William Bengen published his research based on hypothetical withdrawals from simulated $1 million portfolios.1
Using conservative returns and a 50/50 allocation of stocks and bonds, he discovered that 4% was the maximum that retirees could afford to withdraw from their nest eggs (with annual increases for inflation) and still be 90% certain that they would not outlive their savings over 30 years in retirement.
Since then, 4% has been a helpful “rule of thumb” when determining how much people need to save for retirement and how much they can safely withdraw from a retirement account so it lasts throughout their retirement years. But two decades and several major market corrections later, is the 4% rule still valid or should you be working with a different figure?
While experts like Dr. Wade D. Pfau2 and Michael Kitces3 argue that the average withdrawal rate for today’s investors could be as low as 3% (Pfau) or as high as 6% (Kitces), “using 4% can still be a useful way to show clients how little they can afford to withdraw if they want their money to last with a very high degree of probability,” says Joseph Powell, Leader, Annuity Product Development for Brighthouse Financial, Inc. “At Brighthouse Financial we see it more as a guideline to use when starting the conversation about a client’s retirement income strategy. But, it’s certainly not the only discussion point.”
Although talking about the 4% rule can be a good way to begin your discussion, many other factors come into play when developing a client’s withdrawal plan, says Powell. “Working with a client to develop a personalized withdrawal strategy gives you a perfect opportunity to demonstrate your value as an advisor, because you can introduce important factors that affect a client’s income strategy and put them into the correct perspective,” he notes.
“As an advisor, you’ll be looking at each client’s individual circumstances, going a little deeper to look at sources of income, tax-efficient withdrawal strategies, how much to dip into principal and how to generate steady, guaranteed income. You’ll also be helping your clients make sure that their fixed expenses are covered with Social Security, pension payments and other potential secure income sources, such as annuities,” says Powell.
Once those essential expenses are covered, your clients’ investment portfolios can be used to generate money for discretionary spending. If they are sufficiently funded, the client may be able to go beyond the 4% rule, he says.
Of course, the challenge of income planning is even greater for pre-retirees because they don’t have as many guarantees. “Unlike many current retirees who may still have the benefit of pensions to supplement their Social Security, the 55 to 64-year-olds approaching retirement today may not be covered by these guaranteed income sources. Instead, they’ll be drawing on their savings and wanting it to last,” observes Powell.
For this group, creating a steady stream of guaranteed income payments requires more planning and problem solving. But it’s also going to create an excellent opportunity to show the value of your advice and the retirement planning tools and products you can provide.
Your discussion also can include a review of the other factors that influence a retiree’s withdrawal rate. For example:
“A big part of your discussion will be to learn what clients are comfortable with,” Powell observes. “Are they okay with dipping into more principal, can they meet healthcare needs, are they planning to leave a legacy/inheritance?”
Will they spend more traveling, golfing, or entertaining in the early years; perhaps less in their later years?
Does their retirement income need to last more or less than 30 years?
Will purchasing an annuity help the client meet essential expenses in retirement with another steady source of income?
Other factors you may want to explore in your withdrawal discussions include:
- Anticipated health care costs and long-term-care (LTC) expenses
- Income from part-time work
- Amount of savings available to invest and potentially grow for the future
- The client’s risk tolerance, asset allocation and expectations for investment performance
- Required Minimum Distributions
In summary, talking about the 4% withdrawal rule may still be a good place to start your retirement income discussions. But you may want to quickly move your conversation to assess each client’s individual situation, examine the factors in play that may affect his or her personal withdrawal strategy, and find investment solutions, including annuities, to help create a sustainable income plan that your client can live with throughout retirement.