Retirees, Forget the 4% Withdrawal Rule

Let's say you're one of the lucky ones and have accumulated $1 million in your 401(k) retirement account after years of working. But, like many, maybe the pandemic has made you second guess being in the office and your employer is pushing older employees along. So you’ve decided to retire.

How can you safely withdraw the $1 million and not run out of money before you die? You're probably considering two main options: Live for the moment and cash out the money as needed, or cut back and conserve to ensure it lasts for the rest of your and your partner’s life. Both decisions are wrong.

Before I tell you what to do, remember that this money management problem is uniquely American. Other rich nations don't require their elders to make high-stakes, complex financial decisions. To do it right you need to make assumptions about when you and your spouse will die and how financial markets will fare. No wonder research shows elders are less depressed having a guaranteed stream of income worth $1 million than having $1 million to manage.

But let’s say you aren't the typical American. Not only do you have $1 million, but you beat the 30% chance of being in cognitive decline after age 70 and the 35% risk of Alzheimer's after age 85. And you were able to evade financial predation, though people over 80 experience the highest average loss to financial fraud of any age group.

The standard rule of thumb has generally been to draw down 4% of your total assets every year. For many years, financial planners used a 1994 study showing 4% was a safe withdrawal rate if you had a conservative portfolio with low fees and wanted a cushion for the worst case scenario.

It was wonderful to have one specific number; it gave retirees some confidence in the abyss of the unknown.

But now, the only real rule is that blindly sticking with 4% is dangerous. Most experts agree it's no longer safe to just assume the same historic returns for stocks and bonds, so 3% or 3.5% withdrawal rates might be better. Future inflation, especially for out-of-pocket health-care costs, may also make the 4% withdrawal rate too high. Still, there may be others for whom 3% is too low - no one wants to die poor with $25,000 in a shoe.

Some advisers like annuities, but private annuity markets are tricky. The best annuity is to delay claiming Social Security even if you have to tap into your retirement assets. Social Security is inflation-indexed (a great deal in the face of future price hikes) and the payments last until the end of your and your spouses’ lives.  

Tapping into retirement assets and delaying Social Security can result in an annual 8% increase in inflation-indexed Social Security benefits. If you wait until, say 70, you'll have more Social Security income - then you can withdraw closer to 5% and live it up a little because you’ll have fewer years to draw the assets down.  

If you really want some kind of guidance on how much to withdraw, Boston College retirement economist Alicia Munnell suggests following the Internal Revenue Service’s required minimum distributions (RMD) rule.  The IRS requires you to start taking your tax deferred retirement money out at the age of 72 (or 70.5 if you were born before July 1, 1949). At age 72, the IRS requires you to withdraw about 3.9% and at age 90 the RMD is 8.8%.

Congress wants you to spend it while you're alive, since the tax break wasn't intended for your heirs. What's brilliant about the IRS RMD minimum distributions rule is that it adjusts the amount according to your life expectancy. The math is done for you and the required minimum distribution is automatic.

Finally, while it may feel overwhelming to figure out how to make your $1 million last, it's a fortunate problem to have. The median wealth for people in the bottom half of the wealth distribution is about $300,000, with most of that tied up in a house. If the house were sold and the old 4% rule were applied, retirees would typically wind up with $1,600 a month for the rest of their lives assuming average life expectancy - and they still would have to pay rent. Clearly, the American system needs a reboot.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Teresa Ghilarducci is the Schwartz Professor of Economics at the New School for Social Research. She's the co-author of "Rescuing Retirement" and a member of the board of directors of the Economic Policy Institute.

©2021 Bloomberg L.P.

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