Topic 4 – Historical Assumed Safe Withdrawal Rate

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The 4% withdrawal rate rule for financial planning basically said that we could start our retirement at age 65 and we’d have a high probability for success, if we withdrew out our assets from our asset pool at 4% per year. That that money would last until standard mortality, And give us a pretty high probability for success. I’d like to talk a little bit about the history of that rule and what’s changed since 1994, when it was developed. In 1994, the historical safe withdrawal rate that was assumed was developed by a financial planner named William Bengen. It was developed for institutional models, not for retail investors. Retail investors are people like you and I. We only have our pool of money and we have to make sure that it lives as long as we do. So in 1994, this 4% withdrawal rate rule was developed for the institutional management market, but it’s also been adopted on the retail level for individual investors like ourselves. In January of 2013, Morningstar developed a study, which said that the 4% withdrawal rate rule was no longer valid. We had to look at longevity risk and market risk, as factors when we look forward into how long money needs to last. It needs to last longer in today’s time versus 1994. Just look at the CSO tables, CSO tables are predictability of how long we’re going to live, and they’ve moved up. The good thing is, is we’re living longer. The bad thing is in this case is we’re living longer and we may run out of money.

So, then again in 2013 in March of 2013, the Wall Street Journal published an article that said 2% is now the safe withdrawal rate. So I want to just take a minute here and apply some math to this. If in 1994, we had saved a million dollars, we could withdraw out $40,000 per year and safely know that we could live off that money for the rest of our lives. However, now in March of 2013, the wall street journal says, we’ve got to cut that in half. And how much inflation do you think occurred between 1994 and 2013? So we have to cut our income in half, and we also need to plan on a longer life. In October of 2015, the final study was created by Wade Pfau. Wade Pfau has his PHD in retirement planning and works at the American college. Wade Pfau has been cited in several financial publications and his studies about making sure that money lasts as long as we need it to in retirement and what are the risks involved with that. In 2015, October of 2015, five years ago, Wade Pfau determined that now we need to go to approximately one and a half percent. And the reason why is because now a retirement life span no longer, last 20 to 30 years. You could retire at age 60 or 65 and easily as we we saw with our longevity statistics, one of two spouses may actually live beyond age 100. That could be a 40 year span of retirement. We need to factor in longevity. We need to factor in the fact that withdraw rates risk has caused us to be able to take out less from our portfolios. And then we often also add in the fact that inflation is going to decimate our dollars over time.