(2 Minute Read)
As an advisor, there’s not doubt you’ve heard of the 4% Rule when it comes to retirement planning. However, before settling for this standard rule-of-thumb for every client, it’s good practice that you are fully educated on how this rule came about and why it might not apply to most retirees anymore.
Understanding the 4% Rule
The 4% rule refers to the recommended percentage that a retiree withdraws from their retirement accounts each year. Since the 1990s, the 4% rule has been considered the standard withdrawal rate for seniors. The reason the 4% rule exists is because it has been concluded that even during untenable markets, there exists no historical case in which a 4% annual withdrawal exhausted a retirement portfolio in less than 33 years. When accounting for inflation, many seniors include an annual increase of 2% each year, which adheres to the Federal Reserve’s target inflation rate.
As you begin setting up senior clients’ retirement portfolios, it’s necessary to evaluate every situation and make decisions based on withdrawal rates instead of simply adhering to the 4% rule of thumb.
Why it No Longer Applies to Most Retirees
To put it simply, the 4% rule was developed in he early 1990s when interest rates were significantly higher than they are today. During that time, retirees with savings in safe places, like bonds and annuities, were often getting more income than retirees with similar assets do today. According to a research study conducted in 2013, a retiree drawing down savings for a 30-year retirement incorporating the 4% rule had only a 6% chance of running out, using historical interest rate averages. However, using the interest rate levels from January 2013, the same situation had an increased 57% chance of failure. With current interest rate fluctuation, it’s important to consider each and every situation as its own. You should no longer consider this rule a one-size-fits-all strategy.
Treating Every Situation Uniquely
It’s important to recognize that not everyone is going to benefit from the 4% rule. Michael Lonier, a financial advisor in Ramsey, New Jersey, recommends that you take “an actuarial view of the length of the plan remaining.” Or, you can calculate how long the client’s money has to last them. Then, Lonier suggests that advisors look at the client’s current balance net of recent market performance. From there, you can calculate how much is safe to withdraw for a give time period. “If you do the household math, then you have a better sense of how much risk you are taking and whether it’s a good idea,” he said.
When putting together a retirement plan for your senior clients, it’s important that you educate them on the many options available to them. Options like life settlements can help clients make the most out of their retirement plans.