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By Christine Benz | 03-06-2013 02:00 PM

Why You Shouldn't 'Set and Forget' Your Withdrawals

Financial planner Michael Kitces argues why retirees need to establish a monitoring process for their withdrawal rates to avoid making permanent financial decisions for temporary market scenarios.

Christine Benz: Hi. I am Christine Benz for Withdrawal rates have been a hot topic recently with some recent research suggesting that the old 4% rule for withdrawal rates maybe too high. Joining me to discuss that topic is financial-planning expert, Michael Kitces. Michael, thank you so much for being here.

Michael Kitces: Great to be here.

Benz: I'd like to talk about withdrawal rates, Michael. There has been so much research flying around, and it's a really hot topic among our users. Some recent research has actually suggested that the old 4% rule that some retirees had been using was too high, that maybe they should ratchet it down. I'd like to start by doing a little bit of stage setting. First of all, where did the 4% rule come from and how has it evolved as the years have gone by?

Kitces: It's a great question. So, the whole 4% withdrawal rate has been on a little bit of a strange roller coaster over almost 20 years now since the first research came out. When it was originally done, a planner named Bill Bengen out of California in 1994, his criticism at the time was that everybody was running projections based on markets averaging 10% to 12% a year, running in a straight-line projection, which means no assumed volatility and coming up with these sustainable withdrawals of 6.5%, 7%, 8%. And his objection was, "Well, wait a minute, sometimes markets are little more volatile, bad things happen from time to time, and maybe we should back off of that a little bit and find a lower number." And so his approach was to simply look through history and say, well, how bad does it get when you retire on the eve of the Great Depression or heading into the 1970s? What's the worst-case scenario we can find in history, and let's set our withdrawal rate low enough that even if you live through the worst-case scenario, you will make it through OK. If you live through anything better, you'll either finish with a lot of money leftover or you'll simply ratchet up your spending over time. And when he came out with the research, he was roundly criticized for being ludicrously low.

Benz: Too conservative.

Kitces: How can you withdraw 4% in a world where the S&P 500 compounds 15% a year, which was the environment we were in going through the mid- to late 1990s. And so, ironically, as returns have ratcheted down and down now to the point where we're actually talking about whether the 4% number is too high and not too low, the irony is it was actually built on the same conservative framework all along. We keep moving our expectations based on whatever happens to be going on lately, while the research sort of stays where it is and where it's always been that we start our number at a point that's low enough to defend against bad environments. And if we get good environments, we can always figure out how to deal with too much money at some point down the road.

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