Is there a 'magic' withdrawal rate?

Throughout your career you have striven to put aside money for a rainy day fund. You have made the wise decision to fully fund your 401(k) plan each year and even opened an IRA account in the years that you did not have another plan. Now comes the time that you need to reverse this process. Your past savings is now needed for your current and future life style needs. Will you be able to make your savings last possibly 30 years or more? Can you do it and still sleep at night? The biggest decision that you will make in reaching retirement will be deciding on the correct allocation for your assets and then determining a withdrawal rate. Your asset allocation will dictate, along with market movements, the return generated from your hard work. Clearly you will need a combination of stocks and bonds, both domestic and international. This diversification of asset types will help in increasing your earnings over long periods of time. You want to be able to sleep at night so your allocation should be conservative, not speculative; perhaps the traditional 40% fixed income and 60% equities. History has told us that this combination is the most likely to survive a 30-year span. Many will tout the 4% withdrawal rule as a gospel of retirement. For reference, the 4% rule was developed in the early 1990's by Bill Bengen and was published in the Journal of Financial Planning in 1994. The study encompassed major events such as the Great Depression, the stock market decline of 1937-1941 and the 1973-74 recession. It was based on historical data from 1926 to 1976. Bengen declared that no historical case existed in which a 4% annual withdrawal depleted a retirement portfolio in less than 33 years. Not only could you withdraw 4% per year but you also can adjust annually for inflation. Does Bengen's finding still apply today? First, new retirees are experiencing the possible "new normal" marketplace. Interest rates are low at the same time that the stock market might be viewed as overvalued. We could experience a long period of time where returns are lower than the withdrawal rates. In times of underperformance, withdrawals may need adjustment downward, especially in the early years. Medical advances have increased the possibility of having a 30-plus-year retirement phase of life. Along with medical advances, the average health of today's retirees has improved. The 4% withdrawal rule does not take taxes into account. Every dollar that you withdraw from retirement accounts will now be taxable income. If you are withdrawing from taxable accounts also you need to be cautious. Taxable accounts are funds that would be held outside of your retirement plan. Sales of investments can generate capital gain taxes. Interest and dividend are taxed at your ordinary income rate. Municipal bonds are exempt at the federal level but may have taxation at the state level. A portion of Social Security benefits may also be taxable based on your provisional income. Pensions are usually taxable at ordinary income rate. Taxes can play a bigger role than you imagined and typically your deductions at this stage of life will be minimal. The direction of the market will have a large impact on your success of making your money last. You may need to be flexible in your withdrawals. When the market is on a tear you can take a higher withdrawal and when it is down, cut back on spending. In planning a long, successful retirement many factors should be considered instead of just saying, "the 4% rule should be safe." You need to be vigilant in monitoring your investments and rebalancing when necessary so that you are not taking either too much or too little risk. Your health is a primary consideration along with retirement age, life expectancy, possible bequests to heirs, and other factors that may be important to you. A person retiring at 62 has to make their funds last longer than someone retiring at 70. Withdrawal rates and the probability of running out of money in retirement are just pieces of the puzzle to solve. Not everyone is the same, just like there are no "magic" numbers. We all have unique situations and need to be treated as such to insure success. A professional wealth manager will be able to help you determine a withdrawal rate that will satisfy today's needs and ensure that tomorrow's future needs are met. ----- Sharon L. Thornton is Senior Director of Investments for Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534 (585) 586-4680. Published: Fri, Jun 09, 2017