- Key insight: Research suggests a 'flexible 3%' withdrawal strategy could reduce failure rates compared with the popular 4% rule, while leaving a bigger cushion for later retirement.
- What's at stake: The 4% rule may be less reliable for clients with long retirement time horizons.
- Expert quote: "It won't be as much as the fixed rate, on average, but it also means that if you outlive your time horizon, you can basically restart the process and continue getting income for it." — Bryan Foltice, associate professor of finance at Butler University's Lacy School of Business
Less may be more when it comes to retirement withdrawals, according to new research.
For decades, the rule to withdraw 4% of a portfolio has served as
Foltice said he was partly inspired to look into the topic by the
"The failure rate that everyone really focuses on tends to go up higher as the time horizon increases," Foltice told Financial Planning.
The alternative 3% approach could both reduce the failure rate and allow money to be left over, he added.
"It won't be as much as the fixed rate, on average, but it also means that if you outlive your time horizon, you can basically restart the process and continue getting income for it, and so that's how we came up with this 'flexible three' rule," he said. It's a "safe cushion that you would have for being able to take money out."
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Retirement income planning calls for flexibility
Expenses are likely to vary from year to year, and
"This is where personal finance becomes very personal," Foltice said. Advisors must take into account considerations related to taxes and required minimum distributions (RMDs) from individual retirement accounts.
"It would be naive to totally ignore those when you're just going to blindly execute a 'flexible three' plan," he said.
Meanwhile, for some clients, particularly wealthier households, taking withdrawals from IRAs may not be the optimal strategy.
"The first thing that comes into play is client behavior," said Alicia Fuller, founder and managing director of Naples, Florida-based Coastal 360 Capital Advisors, which partners with registered investment advisor Steward Partners. "If they're affluent, they're not going to need that money. They're not even going to want it. They're just going to leave it alone till they absolutely have to
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Consider time horizons
An alternative to planning to withdraw a certain amount annually is analyzing expected income and expenses each year.
"Four percent is a decent rule of thumb," said Charles Failla, principal and founder of Sovereign Financial Group in Stamford, Connecticut — but "a very distant second-best way to do it."
Instead of a 4% baseline, he prefers to analyze each client's situation.
"In my opinion, the only real way to do it is to do the work, which is to put together a cash flow analysis … looking at each year and estimating what you think your inflows will be and what your outflows will be, and that's going to solve for your potential savings target and your potential drawdown target," Failla added.
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While a client is in their working years (also known as the accumulation phase), inflows should exceed outflows, and in their retirement (decumulation phase), earnings are less than expenses, he added.
Failla said he uses an approach called time-horizon asset management integration, or TAMI, which involves identifying needs based on time horizons and withdrawal amounts each year and then putting money in
"No one can really project with accuracy going out 10 or 15 years, so you update that once or twice a year, and you'll have a pretty good idea," Failla said. "Most people know what they need to spend in the next few years, and that you make safe, and the other stuff you can make more moderate, more aggressive."
