Sometimes rules are made to be broken — even when they are long-standing and seem rock-solid. The 4% rule is one, and “Breaking the 4% Rule,” a recent paper by J.P. Morgan makes the case for that.
(The 4% rule advises retirees to withdraw 4% of their retirement account balances each year. That provides them with funds, but also preserves an available balance and allows interest and dividends to replace what was withdrawn.)
The rule, which was born of the stable 1990s and offers predictability, stands in stark juxtaposition with the recent volatility in financial management and markets. That, coupled with low interest rates, brings a static financial strategy into question.
The paper argues that rather than relying on unchanging rules set in the past, investors and advisors should use a strategy based on portfolios and with more robust withdrawal rates. Such a strategy, it says, may help investors better address retirement funding needs.
J.P. Morgan found that in some cases, the 4% rule offers fleeting stability that begins to wane at age 92; in other cases, it can result in the accumulation of wealth a retiree will not use. It also examined using a required minimum distribution (RMD) approach. That reduces the likelihood of premature depletion or excess wealth because it incorporates portfolio experience and longevity, and increases wealth and distributions with age. However, the downside of the RMD approach is that it incorporates the risks of volatility since it is largely based on portfolio value.
Key findings include:
• Maximizing the expected lifetime utility of retirement funds offers a way to quantify the satisfaction portfolio withdrawals bring retirees and could increase their income when they would most likely enjoy the funds they set aside for retirement.
• Managing withdrawals in a way that adapts to changing economic and market environments is more effective than traditional ways to use retirement assets. The paper says such a strategy can help make payouts more consistent and makes it less likely that a retiree will run out of funds or have excess funds that will not be used.
• Age, lifetime income and wealth provide insights into how a retiree’s withdrawals should be adjusted throughout retirement.
The paper suggests a strategy that incorporates these findings would better serve retirees because it would be more robust than that of the 4% rule, but more reliable than the RMD approach.
John Iekel is a writer/editor for ASPPA and its sister organizations, including NAPA Net.
