Retirement income planning has moved far beyond the traditional 4% withdrawal rule. There is now a growing stable of potential income strategies that financial advisors and their clients can turn to when it comes to managing spending and legacy goals during life after work.
Some strategies emphasize predictability and a high degree of safety against running short in old age. Others embrace a risk-taking attitude that maximizes lifestyle early in retirement, while clients are presumably most able to enjoy their wealth. Still other strategies seek a middle ground that accepts flexibility as the means of maximizing utility.
Selecting the "right" approach will depend on a variety of factors, ranging from the client's disposition to the market conditions upon their retirement. While such planning isn't easy, it does represent one of the best opportunities for financial advisors to deliver value for clients.
This dynamic was the focus of a recent episode of the Shares podcast from the American College of Financial services, hosted by Michael Finke, the income researcher and American College professor, with special guest David Blanchett, a portfolio manager and PGIM DC Solutions' head of retirement research.
The duo discuss what they called their "favorite topic" — comparing what's good and bad about various retirement income planning strategies. It's a "retirement income strategy smackdown," as the episode notes suggest. Spoiler alert: While different strategy contenders stand out for different reasons, the duo concludes that flexibility is the key in the real world.
Why the 4% Rule Falls Flat
As Blanchett and Finke explained, the 4% rule is ubiquitous for a few good reasons, starting with it being (relatively) easy for both advisors and clients to understand. Plus, it's so commonly discussed that it offers an almost an ingrained air of authority.
The main issue with such a simple rule, Blanchett said, is that it fails to match up with the complex reality that is retirement.
"Even when people say this is their strategy, nobody actually follows it down to the letter," Blanchett said. "No one, like, calls up their advisor each year and says, well, since the CPI was at 3.8% last year, I'm going to spend exactly 3.8% more this year. They just don't behave that way."
While people can think they are following a safe spending strategy, they are often either under- or over-spending. The rigidity of this framework makes one of these negative outcomes almost inevitable.
In addition, the 4% rule looks only at the individual's private savings accounts and fails to recognize that many Americans receive a guaranteed lifetime pension benefit, such as Social Security.
This means that a retiree's portfolio is generating income in addition to these guaranteed sources, Finke and Blanchett said, thereby providing a safety net that might allow for a different portfolio withdrawal rate.
In past research, Blanchett has found that using more realistic outcome metrics like goal completion, and incorporating things like retirement spending flexibility, results in higher optimal spending levels.
"Based on this research, I think 5% is a more realistic fixed starting point for the average retiree assuming a 30-year retirement period, but the actual target depends on a host of factors," he said.
The Virtues of a Guardrails Approach
The guardrails approach to retirement income attempts to deliver adequate (but not overly high) raises for retirees during upward-trending markets while adjusting downward after market losses. Guardrails can be built in a variety of ways, but the key is making regular adjustments based on evolving success projections.
One example is with a client wanting a retirement success probability of 90%, based on traditional Monte Carlo calculations. If the portfolio experiences strong growth in the first year after retirement and the recalculated success probability reaches 99%, the client could increase spending to a level that would again leave a 90% probability of success.
If the client experienced tough markets early in retirement — or ended up spending more than anticipated — and the recalculated probability of success fell to 70%, spending could be decreased back to a level affording a 90% probability of success.
The appeal of this approach is clear, Blanchett and Finke said. It can help clients continually revisit their plan and feel confident that, despite big market moves or unexpected spending surges, they can move forward with confidence.
