Withdrawing Money from Retirement Savings, Do We Have Enough to Retire?

 By John Berzellini

There are a number of withdrawal methods used by financial planners, which are commented on from time to time in the financial press. Some of these withdrawal methods used in connection with asset allocation programs can put you in the poor house.  Knowledge of the research that supports various withdrawal recommendations, can keep you from being bamboozled by complicated proposals.

I was going thru my files and came across an AARP Magazine article “From a Hedgehog to a Fox” dated Dec. 2010 by Jane Bryant Quinn. I saved the article because subject matter is a hot topic in financial planning circles; and deals with the question, do we have enough money to retire?

In her article Ms. Quinn is giving advice to AARP members concerning withdrawal methods used in retirement planning. Ms Quinn primarily focuses on the withdrawal method used by her personal financial planner. The method is called the total return method. I will also focus on this method, and what Ms. Quinn calls the magic number.

That magic number is an initial annual withdrawal of 4% of your portfolio in the first year of retirement and increases the withdrawal rate by percentage increase in inflation. According to Ms. Quinn “your money should last for 30 years, assuming that you start with a portfolio invested half in diversified stocks or stock mutual funds, and half in diversified bonds, with dividends reinvested”.

This assertion is based on the research of William P. Bengen published 1994 in the Journal of Financial Planning. In 2006 Mr. Bengen updated his work to include small cap stock which moved that so called magic number up to 4.5%.  Mr. Bengen refers to the number as Safemax rather than magic.

Bengen’s original research was done using historic market data. In 2001 withdrawal rates were analyzed by Amerkis, Veres, and Warshawsky. This analysis used both historic data and Monte Carlo simulations and was also published in the Journal of Financial Planning. The results of their analysis indicates “for a 30 year retirement period a 4.5% withdrawal rate succeeds 90% of the time only if the asset mix is very heavily weighted towards stock”.  The analysis also showed, adding an immediate annuity adds more certainty to sustaining a 4.5% withdrawal rate.

In Dec 2007 David M. Blanchett published a paper which considered the effect of a dynamic asset allocation (similar to a target dated retirement funds). Prior research used a static asset allocation. After considering a number of variables he concludes that a balanced static asset allocation would best serve the needs of retirees.

There was series of papers on the subject beginning in 2010 and ending March 2012 published in the Journal of Financial Planning, and authored by David M Blanchett, Larry R Frank, and John B Mitchell. After a rigorous mathematical analysis, they conclude that sequence risk (variability of returns) necessitates that either withdrawal rates or withdrawal amounts need to fluctuate with portfolio values or the probability of not out living your savings will change from year to year.

In August 2011 Wade D Pfa, Ph.D published in the Journal of Financial Planning the article “Can We Predict the Sustainable Withdrawal Rate for New Retires”. He concludes since the Great Recession the magic number is not safe anymore and agrees with the flexible approach to withdrawal rates.

We commend the important research performed by these dedicated financial professionals; however, we believe that more research is needed, before retirees can depend on this method to guide their withdrawal decisions. We also recommend that Jane Bryant Quinn consider hiring a new personal financial planner.

On Feb 12, 2012 John Berzellini posts “Retirement Planning Portfolios at JBA”, warning the public about the use of the total return method and magic numbers.

Watch this video to learn more:  http://www.morningstar.com/cover/videocenter.aspx?id=582877