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Old 05-15-2013, 11:52 AM   #1
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Read it and weep

Many people on this forum are seniors on retirement incomes. This is not good news.

4% Rule for Retirement Withdrawals Is Golden No More


Published: May 14, 2013

ONE thing most retirees want to avoid is outliving their money. Since the mid-1990s many of them have relied on a staple of retirement planning known as the 4 percent rule to avoid that. Although the name says 4 percent, the rule is that if retirees withdraw 4.5 percent of their savings every year, adjusted for inflation, their nest egg should last 30 years, the length of time generally used for retirement planning.
That percentage was calculated at a time when portfolios were earning about 8 percent. Not so anymore. Today portfolios generally earn much less, about 3.5 percent to 4 percent, and stocks are high-priced, which is linked historically to below-average future performance. Many financial advisers are rejecting the 4 percent rule as out of touch with present realities.
The rule was created in 1993 by Bill Bengen, owner of Bengen Financial Services in San Diego, who examined every 30-year retirement period since 1926, reconstructing market conditions and inflation. He identified 1969 as the worst year for retirees because a combination of low returns and high inflation had eroded the value of savings. Using that as his worst case, Mr. Bengen tested different withdrawal percentages to see which one would allow savings to last 30 years. At first 4 percent worked, he says, based on a portfolio with a 60/40 split between large-cap stocks and intermediate-term government bonds. After research, Mr. Bengen decided to add small-cap stocks to the mix and revised his recommendation to 4.5 percent. The 4 percent name, however, stuck.
Michael Finke, a professor in the department of personal financial planning at Texas Tech University in Lubbock, is a co-author of a paper critical of the rule, “The 4 Percent Rule Is Not Safe in a Low-Yield World.” He says Mr. Bengen’s rule doesn’t acknowledge the new economic reality of prolonged low returns. “There haven’t been any historical periods that look like today,” Mr. Finke said. “We’ve never had an extended period where rates of returns on bonds have been so low and valuation on stocks so high.”
Strict application of the rule also does not factor in how important returns are in the early years of retirement, something known as the sequence of returns. “The first years of returns have an outsize impact on your retirement savings sustainability,” Mr. Finke said. He used an example of $500,000 in savings earning zero for the first five years of retirement. Applying the 4 percent rule (that is, 4.5 percent), you will withdraw $22,500 a year. At the end of five years, your portfolio is left with $387,500. If returns go up, they are being earned on a smaller amount of savings than if you had gotten positive returns those first five years or had withdrawn less, Mr. Finke said. “You have less money to use to earn money for the next 25 years.”
High inflation early in retirement can have a similar impact, especially if earnings are also low. Taking out more money just to keep up with the rising cost of living will accelerate the depletion of savings, Mr. Finke said. Although the inflation rate today is 1.5 percent, historically it has been about 5 percent, he said.
Many advisers recommend maximizing earnings by moving away from the 60 /40 portfolio allocation on which the 4 percent rule is based, says Jay Wertz, director of wealth advisory services at Johnson Investment Counsel, a wealth management firm in Cincinnati: As interest rates have fallen and stayed low, “earning 2 to 3 percent on 40 percent of your assets for the next several decades doesn’t really make sense.”
Retirees wanting more certainty in the future might consider investing in a deferred income annuity, Mr. Finke said. Deferred income annuities pay a yearly income that kicks in later in life — usually starting about age 80 or 85. Rather than an investment, Mr. Finke says, it is essentially “an insurance product you buy so that you won’t run out of money in old age.”
Steve Vernon, a retirement consultant with the Institutional Retirement Income Counciland author of “Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck,” advises investing up to half of retirement savings in an immediate fixed annuity, which starts payouts when you retire. The annual income usually ranges from 5 to 6 percent of the amount paid for the annuity, and those payouts, together with Social Security, should be used to cover basic living expenses, he said, and “the remainder of savings should be invested and systematically withdrawn to cover everything else.” Another option is a managed payout fund, especially for people who do not want to actively manage their money. These funds, offered by Vanguard and Schwab among others, invest savings for you and send out a check each month that is a combination of investment income and a return of principal.
Because it is based on how much the investments earn, the payout can vary, Mr. Vernon said. Some funds have target dates when they will end, and others aim to pay indefinitely. (They can even be inherited.) But none come with payment guarantees. If the market goes south, the money in a managed payout fund can run out prematurely. It also can be withdrawn at any time.
Mr. Bengen still feels his rule is a good benchmark, but advises clients to spend more conservatively. When he first came up with the 4 percent rule, “people said, ‘How can anyone live on so little?’ Now they are saying it’s too high. I think it’s a lot to ask people who have saved their whole lives to live on 3 percent.” But Mr. Wertz says the 4.5 percent withdrawal rate may really be too high, especially for those heavily invested in bonds. Those retirees “are likely to fail miserably using the 4 percent rule,” he says. “They aren’t generating the returns to fuel it.”

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Old 05-15-2013, 12:53 PM   #2
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Thanks very much, that's an interesting analysis.

There is a flaw or two, especially with the 30 year retirement concept.

Retiring at 50 would put you at a life expectancy of 80, ok that's a little higher than average life expectancy but not unrealistic.

The issue there is that 50 is not and never has been a realistic retirement age. Some people are fortunate enough but there few and far between.

Many if us HOPE to retire at 60 and that's a realistic hope but it is still low for retirement. I'm seeing people in my industry start retiring around 60 with many more going into their mid 60s.

With that, a 30 year retirement plan is more time than you need. A 20 year plan is more realistic.

That changes the calculations considerably.

The biggest issue I see is the demise of the defined benefit plan. I am VERY thankful of my two union retirements. I have worked in non union 401 k systems for much more time than my union time and the retirement benefits from the 401ks are not even close to the union benefits.

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Old 05-15-2013, 02:37 PM   #3
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I think with any retirement planning advice, you have to consider the source. Many retirement "experts" make their money selling insurance policies. Annuities are just insurance policies. And the commission on most are very high.

Now before I get flamed, I will acknowledge that an annuity or other insurance product CAN be a valuable hedge as a small part of your overall plan. Particularly in high-wealth situations where you have the resources to cover more possibilities.

Personally, I'd opt for retiring earlier if I had excess cash. Time, while I've still got my health, is much more valuable to me than money.

Nobody ever lay on their death bed saying "I wish I'd spent more time at the office."
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Old 05-15-2013, 03:35 PM   #4
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I think putting a healthy percentage of your retirement savings into a lifetime annuity are a great way to provide a guaranteed income. As always you have to shop around and invest only with a solid company! The downside is your kids get less inheritance. No wait, what is the downside?
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Old 05-15-2013, 09:51 PM   #5
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Interesting article.

As an investor, I tend to focus on dividends as much or more than growth. Over the years and depending on the market, my dividends have ranged from 3 to 8%. When the market and my portfolio value tanked in 2008-9, my dividends changed less than 10%. Which was good as I was paying my son's college tuition, etc. Going 5 years with no growth and no divedend income seems like the product of some really poor investment advice.

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Old 05-16-2013, 10:56 AM   #6
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I'm 71, but still active in business. No defined benefit plans or 401Ks. What is put away in qualified plans is now in a SEP IRA. Last year the law required me to start mandatory minimum withdrawals. I am fortunate to still have income without having to hit my IRA too hard.

I believe in a mixture of types of investments. Even at this age, it is possible to be a fairly long term investor. So, I have some in growth, some in dividend producers, and some hedged against recession in an annuity. I learned 40 years ago that I can't out guess the market. Investing should be a long term process.

That being said, seniors are being hit especially hard by this economy. The policy of the government for the foreseeable future has to be low interest rates. How else can they finance the horrendous national debt. Two things that seniors must have are taken out of the CPI. They are groceries and fuel. Duh. That is what people spend money on. Are grocery prices up?
Fuel prices up? That is an indirect tax on incomes. Low investment returns with higher living costs and what will be happening. I can't figure why more people are not more outraged about the mismanagement of our country.
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Old 05-16-2013, 12:03 PM   #7
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Originally Posted by Moonstruck View Post
I can't figure why more people are not more outraged about the mismanagement of our country.
Most people aren't outraged because they are getting their welfare, SSI, food stamps, etc. on time, so what is there to complain about? Besides, who is going to report on the mismanagement of the county - the media? That's not going to happen.


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