Be Flexible On 4% Rule

retirement_roadMy Comments: Increasingly, I find myself working with older clients. After all, I’m an older advisor. From time to time there is a question of how fast you should decumulate your nest egg(s). (I’m not sure if “decumulate” is an approved word, but the intent is to convey the opposite of accumulate.)

The rule of thumb has been to restrict withdrawals to 4% annually to help insure the money will last until you die. Only no one is willing to tell me when they will die. From my perspective as an advisor, I try to find common ground with a client so that in their mind we have reached a reasonable conclusion. It might be 3% or it might be 6%, leaving 4% somewhere in netherland.

May 21, 2014 • Debbie Carlson

Although many advisors have used the 4 Percent Rule for determining clients’ retirement withdrawals, there are times to break it, says J.P. Morgan Asset Management’s chief retirement strategist.

After taking account of longevity, health, investment returns, income and other factors, financial advisors need to talk to their clients about what makes their retired clients happy, said Katherine Roy, executive director of individual retirement at J.P. Morgan Asset Management.

Rather than looking at how much money can be withdrawn from portfolios and then adjusting spending, she said, financial advisors should run simulations to determine how much money clients can spend based on their risk profile and projected investment returns. Retirees should be able to enjoy the early years of their retirement when they are more active but still have enough money for their later years when health-care costs start to rise, she said.

In other words, if an active retiree couple wants to take their family to Europe, they should do that while they are healthy enough to enjoy the time and not worry about making a future trade off. By talking with their clients about their portfolio income and projected returns, financial advisors can guide spending decisions to maximize happiness in retirement and avoid the fear of running out of money at an older age. What she’s concerned about is clients regretting not having enjoyed their golden years, she said.

Roy spoke at the HighTower Apex 2014 conference in Chicago Tuesday and presented J.P. Morgan Funds’ 2014 Guide to Retirement, released earlier this year.

She broke down retirement spending into three categories, “go-go,” “slow-go” and “no-go,” a concept popularized by Michael Stein, CFA, in his book, The Prosperous Retirement, Guide to the New Reality. The concept suggests that in the “go-go” stage, usually the first 10 years of retirement, retirees spend more on travel and other luxuries. In the “slow-go” years, clients stay home more and spending less on luxuries, while in the “no-go” years, they may do even less but spend more on health-care costs.

She said she spoke to Stein, who is now retired, and he told her his own retirement trajectory has fallen into these categories. “But he said if he could go back and write his book, he would add that it doesn’t matter how much money you have, but that you must be happy,” she said.

Thus, she said, taking a dynamic approach to retirement planning is critical for financial advisors and their clients, rather than advisors sticking to the 4 Percent Rule, which basically sets the total withdrawal in the first year of retirement at roughly 4 percent of a client’s portfolio and in every subsequent year that initial amount is adjusted for inflation. In a more dynamic approach, advisors may adjust client’s spending annually so that they spend less when portfolio returns are lower and may spend more when returns are higher.

Roy said one way financial advisors can map out spending in retirement is to make health-care costs their own line item. Health-care costs rise toward the end of a person’s life and have higher inflation than other expenses. By making health care its own category, it will help clients understand what they have available for other living expenses.

What’s critical to making this dynamic approach work, versus sticking to the 4 Percent Rule, is that financial advisors meet at least annually to update the client’s goals, age, portfolio size, market assumptions and other factors.

“It’s important to have discussions with clients, rather than (relying on) just a rule of thumb,” Roy said.