Discover Decoding Retirement on popular platforms like Apple Podcasts, Spotify, or wherever you enjoy podcasts. In 1994, Bill Bengen revolutionized retirement income planning with his introduction of the 4% rule. This rule proposes that retirees can safely withdraw 4% of their portfolio in the first year of retirement and adjust it annually for inflation to ensure their savings last over a 30-year retirement period. Now, after over three decades, Bengen suggests an update to 4.7% for the initial withdrawal in retirement, emphasizing sustainability over time. Before adopting Bengen’s rule, it’s crucial to consider eight key factors for a well-crafted retirement income plan, as highlighted in a recent Decoding Retirement episode. The first step involves selecting a withdrawal scheme that aligns with your financial goals. The 4% (now 4.7%) rule accounts for market fluctuations and inflation, aiming to preserve purchasing power. However, various other strategies exist, such as fixed percentage withdrawals, annuities, or adjusting spending patterns throughout retirement. Understanding your planning horizon, or expected lifespan, is equally important in creating a robust withdrawal plan. Bengen advises adding a margin of error to accommodate longer life expectancies and prevent financial shortfalls in later years. Planning for a secure financial future requires careful consideration and a personalized approach tailored to individual circumstances.
“In the mid-1990s,” Bengen mentioned, “it is important to tend to your retirement savings.” Bengen emphasized the significance of considering tax implications when determining your withdrawal rate, especially when withdrawing from taxable versus non-taxable portfolios. The 4.7% rule assumes a non-taxable account like an IRA, but taxes on gains, interest, and dividends can reduce your sustainable withdrawal rate if not accounted for.
Bengen’s methodology in his forthcoming book involves assuming that the investment account funding retirement withdrawals will cover all income taxes generated by its investment income. Tax-advantaged accounts have zero taxation by definition, while taxable accounts require retirees to factor in ongoing tax liabilities that can impact withdrawal rates. Bengen advised that retirees need to consider the effect of taxes on their withdrawal rate, as higher tax rates result in a greater tax penalty.
Another important factor to consider is leaving a legacy to heirs. Bengen pointed out that the 4.7% rule assumes a portfolio balance of zero at the end of the planning horizon, typically 30 years. If leaving an inheritance is a priority, adjustments must be made to the withdrawal rate, potentially requiring significantly lower annual withdrawals.
Bengen stressed that asset allocation plays a crucial role in determining withdrawal rates. His research suggests that maintaining a stock allocation between 47% and 75%, with the remaining in bonds and cash, results in a sustainable withdrawal rate of around 4.7%. Deviating from this allocation range can reduce the withdrawal rate. Bengen recommended diversifying the portfolio across seven different asset classes over retirement and exploring strategies like a rising equity glide path or guardrails to manage portfolio risk effectively.
Ultimately, Bengen highlighted that retirees must make personalized decisions regarding their withdrawal rate, considering factors like tax implications, legacy planning, and asset allocation.
Attendees enjoyed listening to Galactic with Irma Thomas at the 2024 Newport Jazz Festival held at Fort Adams State Park. Portfolio rebalancing, a crucial strategy described by Bengen, involves adjusting your investment portfolio back to its original asset allocation periodically, typically once a year. This practice not only optimizes withdrawals but also serves as a risk management tool to prevent the portfolio from becoming too heavily weighted in volatile assets like stocks. Contrary to some experts’ suggestions of reducing stock allocation in retirement, Bengen’s research indicates that decreasing stock exposure can actually lower the sustainable withdrawal rate. He recommends maintaining a steady asset allocation or gradually increasing equity exposure over time for better withdrawal rates. Bengen emphasizes the importance of investing in index funds to capture market returns, cautioning against the risks of attempting to outperform the market. Additionally, the timing of withdrawals can impact the sustainable withdrawal rate, with regular distributions throughout the year being a common choice among retirees.
“A higher number of results arises from a withdrawal pattern that is evenly dispersed. Retirement planning is not a ‘set it and forget it’ process; it requires continuous monitoring and adjustments to ensure success. Throughout a 30-year retirement period, unforeseen challenges are likely to occur, and how retirees address them can significantly impact the overall plan’s success. ‘A 30-year plan will inevitably face obstacles, like any other endeavor,’ noted Bengen. ‘How you tackle them is crucial to the success of your withdrawal strategy.’ Each Tuesday, retirement expert and financial educator Robert Powell equips you with the necessary tools to plan for your future on Decoding Retirement. You can access more episodes on our video hub or stream them on your preferred platform.”
