The 4 percent rule of withdrawal in retirement may be outdated, according to research by J.P. Morgan Asset Management.
Low interest rates, extreme market volatility and the negative impact fixed withdrawals had on shrinking account balances in the wake of the 2008 financial crisis have forced the industry to take another look at the 4 percent withdrawal rule of thumb that has been in place for decades.
Since the 1990s, financial professionals have told clients they could withdraw 4 percent of their retirement savings a year without running out of money in retirement.
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But J.P. Morgan found that periodically and systematically adjusting withdrawal rates and portfolio asset allocations in response to changes in personal wealth, age, market conditions and lifetime income may significantly enhance the retirement experience, in terms of both the amount of dollars received and retirees' overall satisfaction with their withdrawals.
A portfolio-based solution using a more robust withdrawal framework may help investors better address their retirement funding needs by embedding market risk, longevity risk and evolving personal investment criteria in a way that a cash-flow-based approach simply can't, the report stated.
The research found that:
- Maximizing expected lifetime utility (potential derived satisfaction) serves as a more effective benchmark of retirement withdrawal success than typical measures, such as probability of failure.
- A dynamic approach to managing withdrawals and asset allocations provides a more effective use of retirement assets than traditional approaches. Adapting to changes in economic and market environments and to investors' specific situations over time can help maximize the expected lifetime utility generated by retirement assets. This type of dynamic strategy may help provide greater payout consistency and reduce the likelihood of either running out of money or accumulating excess wealth that is unlikely to be use by the investor.
- Age, lifetime income and wealth all provide key insights into how to adjust investors' withdrawal strategies throughout retirement. Holding all other factors constant, higher initial wealth levels suggest individuals lower their withdrawal rates, while also increasing their fixed income allocations. Greater lifetime income, through Social Security, pensions and lifetime annuities, allows individuals to increase both their withdrawal rates and equity allocations. Increasing age allows individuals to increase their withdrawal rates, while also decreasing their equity exposure.
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