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Advisors Eye Whether They Should Recommend a 4% Withdrawal Rate in 2023


The 4% rule for calculating portfolio withdrawals has been a tool advisors use to help clients plan for retirement since its inception in the 1990s. In that time, it’s become perhaps the most well-known retirement planning rule of thumb. But the 4% rule, which seeks to identify a safe withdrawal rate that will allow a client’s savings to last 30 years, isn’t settled science. It continues to be debated and researched. In fact, a recent analysis called into question the very methods used to calculate safe withdrawal rates, namely Monte Carlo analysis.

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Given the recent spotlight on safe withdrawal rates, we wanted to see what financial advisors on the ground think about the famed 4% rule – and withdrawal rates in general – in 2023. Here’s what financial advisors should know about the changing landscape and how to implement new withdrawal strategies into their practice.

Withdrawal Rate Is Only a Starting Point

Advisors Eye Whether They Should Recommend a 4% Withdrawal Rate in 2023

The 4% rule is a nice rule of thumb that clients should understand, but it shouldn’t dictate a person’s plan for retirement income, says Matt Sampson, a certified financial planner and senior investment advisor at Arnerich Massena in Portland, Ore.

That’s because safe withdrawal rates don’t always take investment fees and taxes into consideration, he said. The 4% rule is also based on a 50/50 composition of stocks and bonds, which may be an unrealistic asset allocation for today’s retirees. Meanwhile, the 30-year time horizon that the 4% rule assumes may not apply to every retiree’s life expectancy.

“In today’s market environment of high inflation and potentially moderating returns, we caution investors about utilizing generic rules of thumb in creating their retirement plan,” Sampson says.

The withdrawal rate methodology can be a “great starting point for any financial plan,” but it’s only the initial step in the process, says Josh Sailar, a certified financial planner and partner at Blue Zone Wealth Advisors in Los Angeles.

“Risks change, people change and as such, they need to have a plan that considers variability,” Sailar says. “While the rule considers various market environments over that time, it does not consider human behavior and the ability to adjust to asymmetric risk/reward periods.”

Retirement Requires Dynamic Planning

The 4% rule and similar strategies generally take a static approach to retirement income. Sure, they adjust for inflation to ensure a retiree’s annual withdrawals maintain their purchasing power, but they don’t account for people’s varying spending needs throughout retirement.

After all, some research shows that retirees’ spending habits change throughout retirement, traveling in the shape of a smile on a graph. That is, consumption levels start out higher early in retirement, and dip during the middle phase before increasing again toward the end of a retiree’s life when medical and long-term care costs are more common.

As a result, advisors say retirement plans should be more flexible.

“We focus on building dynamic financial plans based on customized modeling, which respond to the evolving needs and goals of clients, and believe this is a much sounder way of ensuring a sustainable retirement,” Sampson says.

Giving Your Clients an Alternative

Advisors Eye Whether They Should Recommend a 4% Withdrawal Rate in 2023

Building a more customized strategy for a client, one that doesn’t rely on the 4% rule or a different safe withdrawal, starts with honest dialogue about their income and spending expectations in retirement. From there, you can develop a nuanced plan that’s tailored to meet their dynamic needs at different points in their retirement journey.

For example, instead of a safe withdrawal rate, Sailar and his firm seek to identify each client’s unique hurdle rate. Also known as a minimum acceptable rate of return, a client’s hurdle rate is the minimum return they require from an investment.

The hurdle rate process for retirement income is similar to the pension model or liability matching, Sailar says, as it structures investments to meet a specific liability during a given time frame.

“We can have an open conversation with the client about all the things they want out of their retirement years and whether or not we can achieve those wishes considering an appropriate amount of risk,” Sailar says. “In contrast, the withdrawal rate assumes you should only distribute a certain (percentage) of your assets at all times so that you can weather all market cycles.”

Perhaps a client wants to spend 70% of their assets during what Sailar calls the early “go-go” years of retirement when they’re still able to travel. The client may plan to taper their spending later when they won’t be as active. As a result, they’d have a higher hurdle rate – meaning they would require a more robust return from their investments – during these earlier years and a lower hurdle rate later.

“As investment professionals, we then select the optimal mix of investments that we believe can achieve that hurdle rate and we have an open dialogue with the client about the potential risks associated with that asset mix,” Sailar says.

Bottom Line

While the 4% rule and similar strategies that rely on calculating a safe withdrawal rate are nice rules of thumb, financial advisors say more is typically required when developing a comprehensive retirement plan. Safe withdrawal rates assume a retiree’s spending habits will remain static. In reality, they will likely vary over the years. Effective retirement income planning needs to be more dynamic and flexible to address a person’s evolving financial needs. Identifying a client’s hurdle rate is one alternative to building a retirement plan around the oft-cited 4% rule.

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