Many of us are familiar with the “4 percent rule.” That’s the annual retirement savings withdrawal amount many retirees have relied on over the years in an effort to avoid running out of money. Meanwhile, more experts these days are now dismissing it, saying the 4 percent rule no longer works amid today’s economic realities.
J.P. Morgan appears to be the latest investment house to bash the 4 percent rule, or any fixed-rate withdrawal plan, and replace it with another approach. Today the financial services firm released what it calls a “Dynamic Withdrawal Strategy,” which shows retirees how they can adjust their withdrawal rates and portfolio allocations based on personal circumstances, preferences and market conditions, says Katherine Roy, the company’s chief retirement strategist.
“Flexibility is really important,” Roy says. “Individuals often don’t know how much they’re going to spend. We’re using a methodology to guide clients in allocation and withdrawal rates as a combination. Say someone is moderately risk-averse and may want to spend more now than in future, but they’re scared. We envision advisers and clients having a discussion … every year to figure out the withdrawal rate and allocation.”
This approach to customizing retirees’ distribution strategies in response to such factors as faltering portfolio balances, higher-than-expected returns or a life-altering event may not be all that new. Retirement experts say it’s based on research that’s been around for at least several years, and perhaps longer. Nevertheless, the approach is a “step in the right direction” because it reflects this newer way of thinking, says David Blanchett, head of retirement research for Chicago-based Morningstar Investment Management.
“It’s silly to base your withdrawal strategy on an amount you decided on 15 years ago,” Blanchett says. “It makes sense to monitor your circumstances continually and update your strategy.”
Financial blogger Michael Kitces made a similar point in a recent post. He cited research from several years ago in which financial planner Jon Guyton recommended that advisers create a “Withdrawal Policy Statement” for clients. The goal was to provide guidelines in advance about how retirement withdrawals would be handled on an ongoing basis and in response to a tanking market. The policy statement would outline what steps should be taken to keep the plan on track. He suggested that having a plan in place might protect people from acting on emotion and doing something rash.
Michael Finke, a professor and director of retirement planning and living at Texas Tech University in Lubbock, has studied retirement strategies for years. He says it’s “refreshing” that the conversation about retirement income is moving toward flexibility regarding the amount people plan to spend in retirement in response to certain factors rather than using a rigid withdrawal rate, which ignores longevity risk and puts people at risk in certain situations.
He says there are two schools of thought when it comes to retirement income. One strategy is to annuitize part of your wealth to protect against longevity risk or invest a lump sum in a way that gives you the highest expected income for the amount of risk you’re willing to take. If that’s not for you, then using a dynamic strategy is best so that if you do poorly on investment returns in your first few years of retirement, you can ratchet down your withdrawals – or spend more if you got lucky in the market.
“The question is, how do you spread that money over your remaining years,” Finke says, “and how do you invest it so you can feel comfortable about taking money out of your retirement savings account? A lot of people feel it’s there just for an emergency. But why did you save in the first place?
“My best suggestion for getting the most out of retirement: Don’t retire unless you can afford the lifestyle you want,” he says. “The age you decide to retire will have a big impact on how much enjoyment you can have in retirement. If you wait until the later 60s, you give yourself a few more years to save, you get more generous Social Security checks and your horizon in retirement is a little shorter” to finance.
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