Are Retirement Rules of Thumb Useful?

I had the privilege of participating in a panel discussion about retirement planning challenges at the recent Morningstar Investment Conference.  Morningstar’s outstanding columnist Christine Benz did a great job of moderating the discussion which also included Christine Fahlund of T.Rowe Price and Maria Bruno from Vanguard.

One of the topics of discussion was the value of retirement rules of thumb, in particular the 4% rule surrounding sustainable retirement withdrawal rates and the 75% rule that address the percentage of one’s working income that they may need to replace in retirement.

The 4% Rule 

This rule, developed by financial planner Bill Bengen, says that a 4% withdrawal rate from your retirement nest egg should be sustainable over a 30 year retirement period.

There was wide agreement among everyone on the panel that 4% was a reasonable starting point, but it was just that a starting point.  Every client situation is different and the level of withdrawals from tax-deferred accounts, Roth accounts, taxable investments and other assets needs to be looked at and managed for each individual retiree on an ongoing basis.  Factors such as the performance of their investments need to be taken into account.  As I mentioned during the session I discuss upcoming cash needs with each retired client on a regular basis as well.

In a recent post on this blog Is a $100,000 a Year Retirement Doable? I discussed how I use the 4% rule as an estimating tool in discussions with a client or prospective client.  Essentially we start with their desired gross cash need in retirement.

Next we look at their total savings for retirement and apply the 4% rule.  For example this would indicate that a $40,000 annual withdrawal from a $1 million nest egg might be sustainable.  We then look at other resources such as Social Security and a pension to determine if the client can reasonably expect to meet their desired retirement cash flow.

The 4% rule is a useful estimating tool in the context of this type of discussion, but it is just a starting point.  At this point in the real work begins.  This includes a spending plan, an allocation or the client’s investments, and most importantly ongoing monitoring of their situation to determine if adjustments are needed.

The 75% Rule   

One of the audience members, a financial advisor, asked me if I had seen any of my clients who are spending less than the 75% of their pre-retirement income in retirement.  This percentage is often cited as a benchmark to estimate one’s cash flow needs in retirement.  This advisor had indicated that this has been his experience with many of his clients.

My response was that I have had this experience with some clients as well.  On the other hand some spend more especially in the early years of their retirement.  As with any rule of thumb, one size does not fit all here.

Everyone’s retirement is different.  With many of us in excellent health in retirement initial retirement spending may even exceed 100% or our pre-retirement income.  This might include travel, the purchase of recreational toys, hobbies, etc.

Later in retirement our activities might slow down resulting in lower spending.  The wild card from a planning standpoint is health and long-term care expenses.  This is both from an actual health standpoint and from issues like the unknown impact of Obama Care.

Rules of thumb can be useful tools to make retirement planning estimates but they are no substitute for detailed financial planning.

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