Cannon Financial Institute

Is 4 percent too much? Why advisors are questioning the popular withdrawal rate

You may have long advised your clients to begin their retirements by taking out only 4 percent of their savings per year, but that could prove problematic in 2015.

Across the country, the average household savings rate is on the way up. According to consumer research firm Hearts & Wallets, the typical American family saved 5.5 percent of their yearly income in 2014. While that is certainly positive compared to the 4.6 percent rate from 2013, there are greater concerns beneath the surface.

Hearts & Wallets found that 65 percent of mass-market households - or those with fewer than $100,000 in investable assets - have debt. Laura Varas, Hearts & Wallets partner and co-founder, emphasized caution in the face of averages.

"The increasing savings rate is good news, but averages can be misleading," she said in the report. "People with less assets are struggling. It's impossible to 'save for retirement' without first getting out from under debt."

"Is the 4 percent rule out of date?"

Change is underway. A sound retirement plan five years ago may be out of date, and out of touch, today, as the market, inflation, debt and other factors fluctuate. From a financial advisor standpoint, the old retirement-savings standbys may not cut it anymore.

One such standby is the "4 percent withdrawal rule." You may have long advised your clients to begin their retirements by taking out only 4 percent of their savings per year, but that could prove problematic in 2015. Here is why many advisors are questioning the 4 percent rule, and what you can do to ensure your clients' retirements remain on track:

Interest rates cause for concern
While there are a number of factors that have impacted the success of the 4 percent rule, one of the biggest has been interest rates. Over the past year, low interest rates ate into the returns for many popular stocks and bonds. For example, if a retiree started to use their savings while interest rates were low, they would deplete their funds faster than if interest rates were higher. At 4 percent, and they'll be out of money before their initial projections.

The general unpredictability of interest rates - and the fact that the 4 percent rule is, at its core, just an estimation - is a sign that it may be time for a more concrete retirement plan. In addition, sticking to an inflation-adjusted 4 percent for 20 or 30 years can be a poor decision. That type of commitment doesn't account for any market fluctuations.

Rule could be square peg in a round hole
Another problem investors have raised with the 4 percent rule is that it applies strict rules to a variable situation. Every person has a unique retirement. They start at the age that works for them, they spend on items that appeal to them and we will never be able to predict how long they'll live. With this in mind, 4 percent could work great for one person and terribly for another.

Overall, the 4 percent rule is designed with a 30-year retirement window in mind. For those that retire at the expected age, this can be a fair estimate. However, 4 percent quickly becomes too much or too little, depending on which side of 60 your clients retire on. That doesn't account for Social Security either. For instance, a client could retire at 70, with the maximum social security payout, and have enough to withdraw anywhere from 5 percent to 7 percent per year.

Your best course of action is to assess each client individually, to determine whether 4 percent is too much, too little or just right. That makes the 4 percent rule a square peg in a round hole.

How can you keep your clients' retirements intact?
The best way to keep your clients' retirements intact is to treat the 4 percent rule less like a rule and more like guidelines. If you already do this, you can take it one step farther - adjust the retirement plan based on the current market.

"A flexible plan can benefit your clients."

In an article for Wealth Management, Voya Financial Advisors president Tom Halloran recommended balancing fixed income with your clients' investment risk tolerance. Younger clients can handle a wider range of investments, and older ones may need to trim back on the risk and focus on safer bets, like corporate bonds or annuities. If they have a strong plan in place, they'll have more savings to withdraw from once they hit retirement.

Halloran also suggested taking a completely different approach. Instead of viewing retirement savings as one large lump sum, break it down into monthly payments. When you sit down with your client, you can:

  •  Plan monthly expenses
  •  Calculate required income
  •  Budget for unexpected costs

This is beneficial for several reasons. For one, it helps the client get a grasp on the overwhelming idea of 30-years or more of retirement savings. Another reason is that it creates a plan that is actionable. Smaller chunks will make it easier to adjust and evolve along the way, all a big plus for clients who are concerned while planning for retirement.

Leave room for retirement flexibility
The fact of the matter is that saving for retirement is an up-and-down affair. One year everything could be great, while another the market could dip and your clients could be worried.

If you build flexibility into your clients' retirement plan, they'll have a much easier time saving. The 4 percent rule is a great place to start, but your clients' individual circumstances will dictate whether or not that withdrawal rate is right for them.

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