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Fahlund: Plan for Flexibility in Retirement

Thu, 21 Mar 2013

The 4% withdrawal rule of thumb may get you in the ballpark, but investors should revisit their drawdown plan as the markets and personal circumstances change, says T. Rowe Price senior financial planner Christine Fahlund.

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Video Transcript

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Knowing how much you can safely withdraw from your portfolio during retirement is a hugely important part of the retirement planning process.

Joining me to discuss this topic is Christine Fahlund; she is a senior financial planner with T. Rowe Price.

Christine, thank you so much for being here.

Christine Fahlund: My pleasure.

Benz: We've seen a lot of discourse about withdrawal rates; I know this is a topic a lot of our Morningstar.com readers are very, very interested in.

Our recent study has actually suggested that the old 4% rule for in-retirement withdrawals is maybe a little bit too high, that people should be thinking more in the 3% range. Let's first discuss what that 4% rule suggested about in-retirement withdrawals?

Fahlund: That 4% rule means simply, you take your starting balance at retirement, take 4% of it out, withdraw it. Next year, you take the same dollar amount out, but increase it for inflation, let's say 3%. The following year, you take that new increased dollar amount, and increase it again for inflation. So the 4% refers to the first year, but not thereafter.

Benz: So the idea is that your income during retirement is relatively fixed if you're using a strict adaptation of the 4% rule. It sounds like you, though, Chris, think that a more flexible dynamic withdrawal strategy probably makes sense--that you want to revisit that initial withdrawal amount?

Fahlund: Yes, I think each year, the 4% rule in our terms at T. Rowe Price, is you're going to come back and review to see if you are on track with your strategy every year. So 4% is just a rule of thumb, gets you in the ballpark, but then if you come back with your new balance and your anticipated new withdrawal amount, you can find out whether you're still on track or if you're at risk of running out of money too soon.

Benz: The idea here, then, is that you want to factor in market action when deciding whether that amount, that dollar amount, is still sustainable for you. You have worked on some research that actually pointed to various strategies at market inflection points, like the 2008 bear market. You actually suggested people could maybe tweak their withdrawal amount a little bit during periods like that. What did you find?

Fahlund: Yes, exactly. What we were worried about was that, just because the markets plummet, doesn't mean your budget changes. You still have the same expenses. So, we suggested that perhaps instead of increasing every year by 3% [inflation], that you hold it steady and use the same amount of withdrawal for say 3, 4, or 5 years in a row, if you need to, until the markets rebound.

Benz: And age has a role in all of this, too. As you age and as you get into your 80s, for example, you could arguably take a somewhat higher withdrawal amount.

Fahlund: Absolutely. Even at younger ages, you might, because if the markets do really well, you're going to find not only are you on track, but markets are doing so well that you could, in the future, increase that amount on a regular basis.

Benz: I guess another point that you've emphasized is that, everyone is spending in the real world, and income needs might fluctuate from year to year based on what you have going on in your life. So you might have emergency expenses or fun expenses, whatever it might be, it might not be static, your income need.

Fahlund: The income needs are not going to be static at all. They are going to change constantly. Not only because of your own planning and your own life, but also what's happening around you, with your children, grandchildren, all of their needs can be incorporated here, too. So your expenses are going to go up and down.

Benz: So all of that calls for generally revisiting that withdrawal rate, even if you found something that made sense to you in Year 1 of retirement, you really need to keep on top of it as the years go by.

Fahlund: That's right. And if you find you're on a downward trend, then you'll know in advance, and you'll start working on getting your lifestyle down to meet those expenses.

Benz: OK. Well, thank you so much for being here to talk about this really important topic.

Fahlund: My pleasure.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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