We’ve all heard it before…many of us have even said it before.
But is it still the case, can you actually withdraw 4% of your account value each year, without running out of money? Over 35 year ago, William Bengen conducted a study that resulted in his statement that 5% was a safe withdrawal rate. What does “safe” mean? It means that you can withdraw 5% of account value at retirement and will never run out of money. His study also assumed that you would be giving yourself a 3% raise each year to adjust for inflation. He later revised this thought process and concluded that 4% is in fact the safe withdrawal rate.
Fast forward 35 years, and you may be hard pressed to find a financial professional that will guarantee that you can take a 4% withdrawal and increase it by 3% each year…and never run out of money.
Why? Because Bengen conducted his study in the 1990’s when the 10-year Treasury was in the 6-7% range….and he was using data from the past 30 years when the 10-year was anywhere from 5% all the way up to 15%. You can see how a 4% withdrawal would be deemed to be safe when half of your money is earning 5-15% guaranteed. Today, we are seeing 10-year Treasury rates at all-time lows, below 1%!
The second and third items that Bengen didn’t account for in his research are increased volatility in the marketplace and sequence of returns.
Of the largest percent losses in the history of the market (Dow Jones Industrial Average), 10 have happened after Bengen completed his study. The days of 500-point losses on the Dow have become commonplace. The 20 largest point losses of all time have happened in the past three years.
The variable that could perhaps have the largest impact on depleting your account, running out of money in retirement, is your Sequence of Returns. This topic gained recognition at the end of the last decade when people who retired in 2007 and 2008, were beginning their Golden Years with a 30%-50% loss from their peak account value.
Making up for a 40% loss is certainly possible when you have a 10-20-year time horizon, are a moderate to aggres- sive investor, or are continuing to add to your retirement account. But if you flip all of those variables around and have only 1-2 years before retirement, you are a conservative investor and are actually withdrawing money from your acct, you can see how making up for a 40% loss becomes a daunting task.
Many retirees weren’t happy hearing they would have to live on 4% of their retirement account, never mind the newly revised number of 2.75%-3.0%, which is now deemed relatively safe. At First American, we have solutions for your clients that want to not only guarantee a withdrawal of 4%-7%, but also want the ability to give themselves a pay raise in retirement.
— By Jason E. Lang, Annuity Specialist