The 4% Sustainable Withdrawal Rate Questioned

One of the fundamental issues surrounding retirement financial planning is determining a credible asset drawdown rate. The problem is that no one retiree is the same as another, so developing a one-size-fits-all solution is impossible.

This blog is part one of a two part analysis.

Some of the differences to consider include the size of one’s assets, the expectation that retirement could last 30 years or more, and that there will be an approximately 3% average inflation rate.

Recently, Guardian Capital LP hosted a webinar, to which we were able to attend virtually – designed to discuss and determine the optimum spend rate for retirees.

During the course of the presentation and subsequent discussion a wide range of formidable descriptions were deployed to articulate the problem – longevity risk vs. financial risk, longevity risk aversion, optimal decumulation, the Fisher Equation.

To the less financially savvy individual, this would be a long and esoteric list. Luckily, we’re here to help disseminate the information.

Introducing Moshe Arye Milevsky

The presentation was led by Moshe Arye Milevsky, a professor at Schulich and a member of the Graduate Faculty of Mathematics & Statistics at York University. His interests include the intersection of pensions and retirement, actuarial mathematics and the history of financial products. So, he knows his stuff.

Professor Milevsky used some of the insights from his influential book The 7 most important equations for your retirement as a conceptual lens through which to view retirement income planning more realistically. The book is fascinating – think Suze Orman meets Stephen Hawking – and treats the subject in an entertainingly anecdotal style.

Science or Rules-of-Thumb?

One of the bugaboos that Professor Milevsky manages to resolve, in both his book and the webinar, is whether retirement income planning is a science or a collection of rules-of-thumb.

Answer: Retirement income planning is a science, and don’t let anyone tell you otherwise.

The 4% Sustainable Withdrawal Rate

In his book Professor Milevsky highlights the work of seven scholars – summarized by seven equations – who shaped all modern retirement calculations. Most modern calculations are frequently based on a series of assumptions such as the 4% sustainable withdrawal rate projected over a 30-year period.

For example, if a retiree adheres to the 4%:30-year rule, here’s how much they could withdraw annually depending on the value of their particular retirement funds (nest egg):

  • $500,000 – $20,000 a year
  • $1 million – $40,000 a year
  • $2 million – $80,000 a year

Based on the 30-year rule, it’s a simple calculation: take your estimated monthly expenses (be realistic) and divide by 4%. Let’s say you estimate you’ll need $50,000 a year to live comfortably. You’ll need a nest egg of $1.25 million ($50,000 ÷ 0.04) going into retirement.

If this sounds simplistic, you may very well be right. And we agree.

If there was a single conclusion to be drawn from the webinar, it’s that the above formula – though widely used – is inadequate. It is too simplistic.

Final Words

According to Professor Milevsky, quoting from his paper (co-authored with Huaxiong Huang) Spending Retirement on Planet Vulcan: The Impact of Longevity Risk Aversion on Optimal Withdrawal Rates:

“Counseling retirees to set initial spending from investable wealth at a constant inflation-adjusted rate (e.g., the widely popular 4 percent rule) is consistent with life-cycle consumption smoothing only under a very limited set of implausible preference parameters – that is, there is no universally accepted optimal or safe retirement spending rate.

Rather, the optimal forward-looking behavior in the face of personal longevity risk is to consume in proportion to survival probabilities – adjusted upward for pension income and downward for longevity risk aversion – as opposed to blindly withdrawing constant income for life.”

The last statement is an important nuance when it comes to retirement income planning that we plan to discuss in our follow-up blog: How to improve your understanding of retirement income planning: Get ready for optimal decumulation.