Retirement Spending: The “Four Percent” Rule Doesn’t Work … Or Is It?

If you’ve been wondering how to make your nest egg last until retirement, you may have heard that you can afford to withdraw 4% a year, and your money will likely last a lifetime.

But that’s disputed by fund management research firm Morningstar, which says it should be replaced with a 3.3% rule.

Around the world, the 4% rule, coined by US financial adviser Bill Bengan, has been used as the basis of retirement plans as a “safe” withdrawal rate for people’s pips, explains Shani Jayamanne of Morningstar.

People who removed and spent 4 percent of their nest eggs each year after retirement needed to be able to make their money last even if they still lived to 30 years.

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The 4 percent rule of thumb has also allowed people to calculate the “magic number” they need to generate the income they want.

“If you have $ 1 million, you could withdraw $ 40,000,” she says.

But, she says, with low interest rates and lower projected future returns on stocks, 4% can be too aggressive.

“All other things being equal, we suggest retirees target a 3.3 percent withdrawal rate instead,” she said.

Earning money in retirement is a growing problem, as the gap between the cost of a reasonable lifestyle and the amount paid in NZ Super increases.

More than half of today’s 65-year-olds can expect to live at least 20 years longer, and more than one in four can expect to live beyond 90, according to the New Zealand Society of Actuaries.

Financial advisor Liz Koh says rules of thumb could be helpful in determining how to manage the costs of living in retirement.

But, she says, “It’s actually pretty complicated for people to get going without counseling. It’s really easy to misinterpret how to implement something like this.

“First, you need to properly allocate your assets,” she says.

Bengen’s 4% rule of thumb was based on a mixed portfolio of 50% bonds and 50% stocks.

Retired handymen often favored other investments like bank term deposits and risky real estate syndicates.

Koh said the 4 percent rule of thumb was a very simplistic approach to disbursing, the term used for a retiree gradually spending their fortune.

“There is no one right answer on how to accumulate wealth,” she said. “In my opinion, there are different types of retirement expenses.

“There are your living expenses, which is the cost of staying comfortably alive, your housing costs, your food.

“Then there are big lump sums that you might want to spend on things like travel, buying a car, big house maintenance,” she says.

Morningstar’s rule of thumb ignored this.

Next year, Money author Martin Hawes will publish a retiree’s guide to turning nest eggs into income.

His research led him to conclude that 5%, or 6%, were better safe withdrawal rates.

“The inventor of the 4% rule, William Bengen, now says that 4.5% and even 5% is better,” says Hawes.

Spending did not decline evenly in retirement, with people spending more in their first working years of retirement, he says.

“As you get into the late ’70s and’ 80s, there seems to be a natural cut in your spending, and the 4% is running on a flat line. This assumes that your expenses during your first week of retirement will be exactly the same as the week before your death, ”says Hawes.

“I don’t think it’s fair.”

Hawes would like to see more research on the strategies New Zealand retirees use to tap into their retirement savings.

Koh and Hawes both said many people did not spend a lot of money in retirement fearing they would run out of money.

“If you’re really going to get the ‘check to the funeral director,’ which is to take out the last dollar, most people don’t,” says Hawes.

Koh agrees: “One of the biggest problems we have with retirement is that we spend less.

“This modeling is based on a 30-year retirement. If you die sooner than that, your kids will receive a bonus, ”she says.

Ralph Stewart, former CEO of ACC, started Lifetime Retirement Income to help people turn their savings into income without worrying about running out of money. Hawes is president of the company.

“We give each person their unique annuity factor,” says Stewart.

The annuity factor is how much they can spend each year of their capital. Each person’s annuity factor is based on their age, gender, how long they are likely to live, how much they want to spend, how much they want to leave behind, and even when they want to spend.

Women, for example, tend to live longer than men, but people with poor health may choose a shorter life expectancy.

People in good health or fearful of outliving their money may set a higher expected age of death.

Clients often seek out the business after a few years of retirement, which means they may not need their capital to last for Bengen’s 30-year period.

For people around 70, the chosen average pension factor would be around 6.5 percent, says Stewart.

Stewart says a lot of people think of trying to live on an income generated by their investments after retirement, but most people needed to spend both income and capital.

But fear of running out of money could trap people in needlessly pinched pensions.

“People come to us to make sure they won’t burn out,” says Stewart.

The company’s system was based on work done by actuaries from the New Zealand Society of Actuaries. In 2017, the company released a document called Decumulation Rules of Thumb.

He updated it last year.

It previously contained a rule of thumb of 6 percent, whereby a retiree took 6 percent of the starting value of their retirement savings each year.

But, his updated paper says, “To get an equal opportunity of income up to age 88, as our 2017 paper shows, an income of around 5% of the initial balance each year should be drawn, rather than 6. %. . “

This was based on a “balanced” portfolio made up of 60% stocks and 40% bonds.

The document cautions readers, “We recommend that people view the rules not as predictions, but as a way to consider the pros and cons of the rule that might work for them.

“The question is not ‘How much income should I commit to taking for the next 25 years or so?’ but rather, “How much income can I comfortably take for the next year or two until I revise?” “”

Stewart says that each year Lifetime Retirement Income reviewed each client’s payment plan with them.

Morningstar paper can be found here. The New Zealand Society of Actuaries article is available here.