That’s according to a new paper from investment adviser Morningstar, which shows that the decades-old guidance on how to spend down savings after retirement — commonly known as the 4 percent rule — may no longer provide sufficient lifetime security.
That set off alarm bells across the retirement-planning world, but it’s probably not a reason to panic.
Of greater concern is a broader problem that the rule can’t fix: Many Americans lack enough money for their post-work needs, no matter what their withdrawal rate is.
Here’s the bigger picture. The traditional way of thinking about retirement planning in this country involves a three-legged stool: One leg is Social Security, one is the pension system, and the other is personal savings. Beginning in the 1980s, that stool has been getting increasingly off-balance. The share of employees in the private sector with access to a guaranteed pension in retirement is falling. Defined-contribution plans including 401(k)s and individual retirement accounts (IRAs), initially developed as supplements to pensions, are increasingly replacing them.
Enter the 4 percent rule, seemingly designed to offer reassurance. Financial planner Bill Bengen, who originated the theory in the 1990s, posited that if retirees with a personal portfolio evenly split between stocks and bonds withdrew 4 percent of their assets the first year they stopped working, they could take out the same amount — adjusted as necessary for inflation — each following year for the rest of their lives.
The strategy, which Bengen showed worked for almost any 30-year period of stock market history studied, would make the chances of running out of money all but infinitesimal.
The new Morningstar paper, written by Christine Benz and John Rekenthaler, homed in on a flaw in the original analysis: a very human inability to predict the future. As the warning on every financial prospectus reads, past performance is no guarantee of future returns. (And when you’re reliant on stock returns for your income, sharp drops like Friday’s rattle your confidence.)
Interest rates are at near record lows. Stock market valuations — that is, a company’s equity price-to-earnings ratio — is, conversely, at near record highs. Inflation is picking up. As a result, for the best chances of making the money last, the withdrawal rates needs to drop to 3.3 percent, the authors conclude.
The change sounds minor — but for retirees and near-retirees, this is an unwelcome reminder that the future is more precarious than many want to admit.
Of course, anyone who was really paying attention knew that the 4 percent rule, while it sounded good, was something of a gimmick, a way of thinking
about how to spend down in late life. Expenses — think medical costs, or a grown child suddenly in need of financial help — tend to be unpredictable in a way that makes it hard to fully commit to a firm drawdown number.
More important than the difference between 3.3 and 4 percent is the demonstrated reality that about half of working-age households are at serious risk of lower living standards in retirement, no matter their drawdown rate. That’s not simply because they’d rather dine on avocado toast and buy lattes.
The extraordinary expense and rampant inequality and unfairness of American life plays a major role in retirement insecurity. Only two-thirds of private-sector workers have access to a defined-contribution plan at work. Almost 90 percent of the top quartile of earners were that lucky, compared with a minority of those from the bottom 25 percent. Black Americans are significantly less likely to have or use retirement accounts than Whites.
At the same time, data compiled by the Center for Retirement Research at Boston College reveals that at the age of 30, workers who took out student loans had less money set aside in retirement accounts than those who graduated without debt, missing out on the compounded value of early savings.
Many Democrats would like to do something about all this. Proposals ranging from student debt forgiveness to free public college tuition could buttress individual retirement savings. Portable retirement accounts, maintained by independent boards, would give everyone easy access to a workplace savings plan, not just those lucky enough to work for an employer that offers one. And legislation recently introduced by Rep. John B. Larson (D-Conn.) would increase the stability of Social Security and raise benefits, in part by largely eliminating the payroll tax cap.
What both retirees and future retirees want is to know whether they will have enough funds to get through retirement. As this argument over the 4 percent rule shows, that cannot be guaranteed. But we could make retirement a lot easier. We need to get on it.