The rules that govern retirement spending are changing. No
surprise, then, that retirees have lots of new questions.
For decades, conventional wisdom was that retirees who
wanted a high degree of certainty their money will last should spend no more
than 4% of their savings in the first year of retirement and adjust that amount
annually to keep pace with inflation. Research firm Morningstar Inc. MORN
-1.68% upended that thinking earlier this month with a recommendation that
people spend no more than 3.3% of their savings at the start of their golden
That news prompted a litany of questions from readers of The
Wall Street Journal. Is Morningstar the only corner of the money management
world arguing for a lower withdrawal rate? Is it ever OK to draw down more than
4%? Can I keep my retirement spending the same if I increase my allocation to
stocks, or international investments?
The Morningstar math is straightforward. Someone with a $1
million portfolio would have to draw down $33,000 in year one of retirement
instead of $40,000 under the 4% rule. Assuming 4% inflation, that same retiree
would have to live on $34,320 in year two and $35,690 in year three, regardless
of market performance. Morningstar made its adjustment because of lower returns
expected from stocks and bonds in the years ahead. If inflation, which is at a
30-year high, remains near today’s level for an extended period, even 3.3%
might not be low enough, according to Morningstar.
How you should react to this new guidance is anything but
simple. Here are answers to some of the most pressing questions from readers:
Does everyone agree the 4% rule should be revised to
No. Some have argued it should go even lower. A group of
researchers that includes American College of Financial Services professor Wade
Pfau concluded in a 2013 study that the initial withdrawal would have to be
capped around 2.5% for investors to have a high likelihood of making their
money last over a 30-year retirement.
That calculation, based on forecasts of future returns,
assumed investors had 50% of savings in stocks and 50% in bonds.
But the man who in 1994 came up with the 4% rule—retired
financial planner Bill Bengen—isn’t conceding that 4% is too high. In fact, he
said investors can go even higher if they are willing to diversify their bets.
That said, he agrees future returns will likely be below average over the coming
And you can in fact withdraw a higher percentage of your
balance if you think your life expectancy is likely to be shorter than 30 years
(the period typically used to arrive at these calculations). For example, a
couple who retires at age 75 and expects to live another 20 years can start by
drawing down roughly 5% of savings, said David Blanchett, head of retirement
research at PGIM, the investment management group of Prudential Financial Inc.
Can I withdraw more than 4% if I invest a high percentage
of my portfolio in stocks?
It isn’t a good idea, according to Mr. Bengen. The 4% rule
is most reliable for portfolios with 50% to 60% in stocks and the rest in
If you invest less than 50% in stocks, your returns may be
insufficient to support a 4% inflation-adjusted withdrawal for 30 years, said
Mr. Bengen. With more than 60% in stocks, your portfolio may lose so much
during a bear market that it won’t be able to recover.
“It’s good to be in the middle,” said Mr. Bengen.
What if I diversify my portfolio further?
It might help, according to the father of the 4% rule.
Adding international stocks and the stocks of small U.S. companies to a
hypothetical portfolio would have earned enough to justify an initial
retirement withdrawal of 4.7% during any 30-year stretch of the last 95 years,
Mr. Bengen said.
Mr. Bengen recommends holding roughly 11% each in
international stocks and U.S. large, midsize, small, and microcap stocks. He
also recommends allocating 10% to Treasury bills and 35% to intermediate-term
Still, Mr. Bengen warns that today’s high valuations in both
stocks and bonds have no parallel since 1926. As a result, he recommends
starting with an initial withdrawal rate of 4.4% or 4.5% if you can get by on
that amount, versus 4.7%.
How does high inflation affect my spending plans?
When inflation rises, the risk of portfolio depletion also
rises. Consider Judy, who has a $1 million portfolio. She spends 4%, or
$40,000, in the first year of retirement. If inflation is 2% in years two and
three, her spending would rise to $40,800 and $41,616. But if inflation is 6%
instead, her withdrawals will be $42,400 in year two and almost $45,000 in year
When inflation rises, investors end up with higher dollar
withdrawals for the rest of their lives, putting a greater burden on the
portfolio, said Mr. Bengen.
“Inflation is a pretty serious threat for retirees, which is
why I’m troubled by what I see now,” he said.
What about annuities? Is that another way I can withdraw
more from my savings?
Yes. So-called “immediate annuities” convert a lump-sum
payment into an annual income for life, said Mr. Pfau.
A 65-year-old woman who buys a $100,000 immediate annuity
today will receive about 5.6% a year of the amount she invested. In contrast,
the yield on a 30-year Treasury bond is about 2%.
The extra income from annuities is the result of the
requirement that you surrender your principal to the insurer. Each payment
consists not just of interest, but also of a portion of principal, prorated
over your remaining life expectancy, plus a portion of the remaining principal
of other annuity purchasers who died before recouping their costs.
Insurance companies don’t charge fees on immediate
annuities; instead, they invest your money and pocket the difference between
what they earn and the income they promise you.
The payments are guaranteed to continue for life. But when
you die, they stop—regardless of whether you’ve recovered the amount paid. To
protect your principal, you can purchase a death benefit, but you must settle
for a lower income.
Another way to expand your guaranteed income is to delay
claiming Social Security, said Mr. Pfau. Unlike most annuities, Social Security
is adjusted annually for inflation. If you delay claiming from age 62, when
people first become eligible, to age 70, you will miss eight years of Social
Security benefits. But your benefit at age 70 is about 77% higher.
Once you get past age 80, you will “be in better shape for
the rest of your life,” said Mr. Pfau.
The Internal Revenue Service requires me to pull money
from retirement accounts starting at age 72. What if that pushes me above my
annual withdrawal target?
Once you are 72, the law requires you to withdraw a set
minimum amount annually from your traditional retirement accounts, or face an
excise tax on the amount you should have taken.
To determine your required distribution, divide your
traditional individual retirement account and 401(k) balances as of the
previous Dec. 31 by your life expectancy in the IRS Uniform Lifetime Table. As
people age and life expectancy declines, the percentage they are required to
withdraw rises. For example, a 72-year-old must withdraw 3.9% of the balance,
but for an 80-year-old, the rate is about 5.4%.
The 4% rule can help you determine how much of your required
distribution you can spend. If the 4% rule says you should spend less, take
your required distribution and pay the taxes due. Then, deposit whatever
exceeds the recommendation under the 4% rule into a taxable account, said Mr.
“You have to take your required distribution, but you don’t
have to spend it,” he said.
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