If there’s one topic guaranteed to get the attention of retirees and would-be retirees, it’s the 4% “safe” annual withdrawal guideline popularized by the American financial planner, William Bengen. I alluded to this last week when I wrote about Wes Moss’s “The 1,000-Bucks-a-Month Rule” rule. (For every $1,000 of monthly retirement income you need $240,000 capital to generate it.) In the book in which Moss revealed this guideline, he clarified that his rule was based not strictly on Bengen’s 4% guideline (plus inflation adjustments) but on a 5% annual withdrawal made up in part from high-yielding “income” investments (like dividends), and partly from a combination of capital gains or breaking slowly into capital.
Here in Canada, whether you’re talking 4% or 5%, things are complicated once you reach your 70s by the fact Ottawa insists on minimum annual withdrawals from Registered Retirement Income Funds (RRIFs) that start at 7% and move sharply higher as the years pass. That’s a topic for another day but suffice it to say that if you’re forced to withdraw 7% a year and are only earning 3% or 4% or 5%, you’ll likely start to dig into capital.
Canadian actuary Fred Vettese (chief actuary for Toronto-based Morneau Shepell) tapped into this nerve in July when he wrote in his column in the Financial Post that “the good news about the 4% withdrawal rule is that it might be too low.” The piece generated dozens of comments, many of them quite insightful. Vettese, who is also the author of The Real Retirement, noted that the 4% rule is for people who never want to break into capital. But in his “real” retirement, there’s a balance between running out of money altogether and dying with a giant nest egg destined to cheer up some combination of your heirs and the Canada Revenue Agency. Most will opt for a nest egg that’s “somewhere in between” these extremes.
In an interview, Vettese told me he wrote the piece after giving interviews on the subject to various media outlets about a truly “safe” withdrawal rate. “Everyone in the market said it used to be 4% but now it’s closer to 3% with lower returns and interest rates.” Indeed, in another FP article on the weekend, Michael Nairne, president of Tacita Capital Inc., invoked the same rule, noting that back-testing to 1926 found that for balanced portfolios (50% stocks, 50% government bonds), the 4% rate would last at least 33 years and usually at least 50 years. But in the modern era of low interest rates and richly valued stocks, Nairne says more recent studies find the 4% rate will see portfolios run out of money in under 30 years. Therefore the “safer” withdrawal rate is closer to 3%, Nairne says.
But remember that’s if you never want to deplete capital. Vettese says “no one I know says they want the capital they have at retirement growing in real terms. The 4% rule only makes sense if you’re trying to keep your nest egg intact over the long term.”
As Moss notes, in real life there’s volatility. While you may want to draw 4% or 5% on average each year, sometimes the financial markets will do great and you’ll enjoy 10% annual returns on your portfolio; on the flip side, there will be years when it loses 2%. Knowing this, Vettese says retirees shouldn’t spend the entire 10% gains in the good years, since they need to hold back some of the gains so you’ll still be able to pull out the 4% in the bad years. He assumes living to age 90.
Vettese also has some interesting thoughts on annuities. We’ll save them for a future post.