Many financial advisors like Brian Poncelet have been telling their clients for years that in order to successfully plan for retirement they should follow the four percent rule. The thought process being that if you put away four percent each year, you will accumulate enough of a nest egg that you will live comfortably for at least 30 years in retirement.
The problem with a generalized rule of thumb in today’s economy is that interest rates have been low for nearly a decade and retirement is growing more expensive. There are so many factors to the amount of funds necessary to retire that it can’t be quantified by a general rule. It’s also fair to say that when the idea of 4 percent withdrawal was mostly widely accepted by financial advisors, the average life expectancy was much shorter. Most Americans are still looking to retire at 65, but they are living longer without accumulating an income. Consider the fact that a woman reaching age 65 in 1970 was most likely to live 17 more years – that number is now 20. For men, it was 13 – and now it’s 18.
Brian Poncelet comments further that “Wealthy households do not have to worry as much about these issues since they are more likely to have accumulated more than enough money to support themselves in retirement.”
Brian Poncelet says the counterpoint is those with less savings have less of a margin for error. PwC recently analyzed behavioral trends of retirees. What they discovered is that spending rates are not consistent over the retirement phase. Most people overspend the first few years of retirement and then things drop considerably only to ramp up towards the end of life, which may be caused by an increase in medical bills. Obviously, the four percent rule was one created with an expectation that spending amounts would be consistent over the retirement period.
In addition to the above discovery, research published in 2013 by Wade Pfau of The American College, David Blanchett of Morningstar Investment Management and Michael Finkle of Texas Tech University found that when you utilize only historical interest rate averages and factor in the four percent rule, there was only a six percent chance of running out of funds. However, when they ran the same test utilizing 2013’s interest rates, which was the year they ran the study, the odds of running out of funds soared to 57 percent. Obviously, in a low interest rate environment, the four percent rule simply can’t be trusted.
While old tricks and tips may not be as relevant today, Brian Poncelet says that there are plenty of modern tools that can help investors and their advisors understand how they must save for retirement. Technology is making it easier to calculate how much money needs to be put away based on the earning habits and interests of the parties. While there’s no longer a one-size-fits-all solutions, there’s still plenty of resources out there that can help people save the proper amount for their unique needs.