Goodbye 4%, hello age divided by 20
Experts say nest eggs are more fragile than in the good old days, but a new withdrawal rate can prolong their lifespan
How much can you safely withdraw from your retirement account each year without running out?
Well, in the good old days, you could withdraw 4% per year from your nest egg and it would last 30 years. Or at least that’s what financial planner Bill Bengen famously wrote some 22 years ago. But now, in a world where interest rates float around 0% and where investment returns are likely to be low for some time to come, blindly withdrawing 4% per year would be a disaster for your nest egg and ultimately your standard of living.
So how might you determine a safe percentage of savings to spend in today’s world?
THE ‘FEEL-FREE’ RETIREMENT SPENDING STRATEGY. The latest in a long history of research on the subject comes from Evan Inglis, a senior vice president at Nuveen Asset Management and a fellow of the Society of Actuaries. Inglis’ recommendation: Simply divide your age by 20 (for couples, use the younger spouse’s age).
So, for example, someone who is 70 could safely spend 3.5% (70 divided by 20 equals 3.5) of their savings, while someone who is 80 could withdraw 4% (80 divided by 20 equals 4) and someone 65 could withdraw 3.25%.
“That is the amount one can spend over and above the amount of Social Security, pension, employment or other annuity-type income,” Ingalls wrote in his paper. “I call this the ‘feel-free’ spending level because one can feel free to spend at this level with little worry about significantly depleting one’s savings.”
What’s so great about this strategy? According to Inglis, it’s “an easy-to-determine and remember guideline for those who do not have the time, expertise or inclination to do a lot of analysis.”
Other strategies, by contrast, require too much thinking. For instance, the original 4% rule of thumb had you adjusting the amount you withdrew each year for inflation. (Good luck with that.) And the income-replacement ratio rule of thumb, where you try to replace 70% to 80% of pre-retirement income from a variety of sources, was an exercise in futility as well.
THE 3% RULE. Truth be told, there’s an even easier strategy to use to make sure you don’t outlive your assets. Simply withdraw 3% year in and year out.
“Three percent could be viewed as a more conservative and simpler version of the wellknown 4% rule,” Inglis wrote.
NOT ALL AGREE. Some experts take issue with Inglis’ age-divided-by-20 strategy.
“I agree that the proposed guidelines are a simple and conservative rule of thumb,” says Dirk Cotton, a financial planner and author of the Retirement Café blog. “As with all rules of thumb, this one has issues.”
While 3% is probably a good conservative starting point at age 65, age divided by 20 becomes far too conservative in late retirement, Cotton says.
Moshe Milevsky, a York University professor, suggests 5% is a more reasonable withdrawal for a man age 80 than 4% and that 10% is more reasonable than 4.5% at age 90.
“So (Inglis’) approach is likely to result in a lower standard of living than might be achievable,” Cotton says.
Inglis doesn’t disagree that a higher withdrawal rate might be more appropriate later in life. But he says his strategy balances the need for simplicity with the need to be accurate. Plus, he says, it’s unlikely that people will want to spend more as they age.
OTHER CONSIDERATIONS. Of course, there are all sorts of things to consider before you just adopt the age-divided-by-20 strategy. Here are some of the questions Inglis suggests asking when applying this rule (or other similar rules):
Do you have long-term care insurance? If you do, you can spend a little more. If you don’t, you may want to reduce your spending a bit.
Will you lose a significant amount of annuity income when your spouse dies?
Will you pay significant income taxes?
What if interest rates go up? First of all, you can’t expect that they will. You can probably spend a little more if they do, but if rates go up by 2 percentage points, you can’t increase your feel-free rate by 2% of your savings. The best advice is to stick to the divide-by-20 rule for the foreseeable future.
Do you want to pass on a certain amount to your kids or charity? Adjust your spending accordingly.
Truth be told, there’s an even easier strategy to use to make sure you don’t outlive your assets. Simply withdraw 3% year in and year out.