What You Need to Know
- The difficulty experienced by retirees between 1966 and 1995 is the basis of the 4% withdrawal rule.
- Retirement simulations are useful, researcher Wade Pfau says, but they are limited in profound ways.
- He suggests rerunning simulations as circ*mstances change and using flexible spending approaches.
Most financial planning professionals are able to articulate the basic premise of the 4% safe withdrawal rule, but that doesn’t mean they fully appreciate either the real power of the retirement spending framework or itssignificant real-world limitations.
They also might be unaware of where the 4% figure came from. As retirement income researcherWade Pfaurecently pointed out, the popular guideline for how much money is safe to spend annually in retirement was calculated based ona retirement beginning in1966.
“In the original analysis, this was basically the toughest 30-year period on record for a new retiree,” he saidon a recent episode of theEconomics Matterspodcast.
In general, financial planners struggle to fully understand and accurately contextualize Monte Carlo simulations — of which the 4% withdrawal rule is perhaps the most famous and widely cited example, Pfau said.
As Pfau told podcast host and Boston University-based economistLaurence Kotlikoff, the topic of poorly contextualized Monte Carlo simulations and the shortcoming of the 4% withdrawal rule might sound like overly academic or esoteric matters, but they are actually of paramount practical importance to financial planners serving investors focused on retirement.
“Don’t get me wrong, the 4% rule does have a lot of practical use,” Pfau says. “It is, to put it simply, a research guideline that can allow for the start of a solid conversation about income planning.”
What is critical to understand, however, is that this type of modeling is highly sensitive to the inputs and assumptions being used, Pfau warns. Monte Carlo simulations, with their focus on generating binary success-failure probabilities, can mask a lot of nuance in middle-ground cases where success and failure are harder to define, “such that we have to view all retirement simulations with a significant degree of caution.”
According to Pfau and others, an overreliance onprobability-focused Monte Carlo simulationsis one key problem for the planning industry to address, and another is figuring out how to more clearly and effectively communicate with clients about the interplay of complicated sources of risk.
Ultimately, Pfau argues, now is a great time for advisors to learn and leverage some of the key planning concepts being put forward by academics, and he says studying the history of the 4% withdrawal rule is a decent place to start.
Where the4% Rule Really Comes From
“You might not expect it, but we can actually still learn a lot by going back and looking at the study that first brought about the 4% withdrawal rule,” Pfau says, citing the work of Bill Bengen,the researcher andretired advisor credited with inventing the spending framework.
“For example, it is really interesting to look back and see that the 4% ‘safe’ withdrawal figure itself comes from what would have been safe to spend during the 30 years from 1966 to 1995,” Pfau explains.
As Pfau notes, the period in the late 1960s and early 1970s was a tough time to retire. Inflation ran rampant, and the S&P 500 scored several significantly negative years in that period. Returns were particularly poor in 1966, 1969, 1973 and 1974.
“Notably, after 1982, or about halfway through the 30-year retirement that started in 1966, the markets actually did really well,” Pfau observes. “The key takeaway here is that, even though the average return to a portfolio was decent between 1966 and 1995, the sequence of returns was really difficult for retirees to deal with.”
FAQs
Inflation ran rampant, and the S&P 500 scored several significantly negative years in that period. Returns were particularly poor in 1966, 1969, 1973 and 1974. “Notably, after 1982, or about halfway through the 30-year retirement that started in 1966, the markets actually did really well,” Pfau observes.
What is the best year for retirement? ›
First, the earlier you retire the longer your money has to last. If you retire at age 40 and expect to live to age 90, for example, you'll need to save enough money to last a half-century. Waiting until you're 65 to retire, on the other hand, can ease some of the pressure to save.
Why not retire at 60? ›
The average retirement savings at 60 are not enough to cover the average expenses of Americans 65 and older. According to the Federal Reserve's 2022 Survey of Consumer Finances, the average retirement savings of Americans in the 55-64 age group are $537,560.
What year do most people retire? ›
What is the average age of retirement in the United States? Right now, the average age for men to retire is 65 while the average age for women to retire is 63. While many people say they will work for as long as they can, others retire earlier than expected.
What are the top worst states to retire in? ›
Kentucky, New Jersey, and Mississippi top the list of the worst places to retire in the U.S. in 2024, according to a new survey from WalletHub. The study compared the 50 states across 46 key indicators, from tax rates and the cost of living to access to quality medical care and fun activities.
What is the golden age of retirement? ›
There was never a “golden age” of retirement in America. Retirees 30 or 40 years ago did not have it better than retirees today. Retirees do not have it so much better in other countries. There is no nirvana of free everything for the over-65s.
What is the happiest age to retire? ›
When asked when they plan to retire, most people say between 65 and 67.
At what age do you get 100% of your Social Security? ›
The full retirement age is 66 if you were born from 1943 to 1954. The full retirement age increases gradually if you were born from 1955 to 1960 until it reaches 67. For anyone born 1960 or later, full retirement benefits are payable at age 67.
How many 60 year olds have nothing saved for retirement? ›
About 27% of people who are 59 or older have no retirement savings, according to a new survey from financial services firm Credit Karma. To be sure, that's the same share as the overall population, yet boomers have less time to save for retirement given that the generation is now between the ages of 59 to 77 years old.
Why is increasing retirement age bad? ›
Raising the retirement age amounts to an across-the-board cut in benefits, regardless of whether a worker files for Social Security retirement benefits before, upon, or after reaching the full retirement age. When the full retirement age is increased, retirees have no way to avoid the cut.
Social Security offers a monthly benefit check to many kinds of recipients. As of December 2023, the average check is $1,767.03, according to the Social Security Administration – but that amount can differ drastically depending on the type of recipient. In fact, retirees typically make more than the overall average.
How much money does the average American retire with? ›
Data from the Federal Reserve's most recent Survey of Consumer Finances (2022) indicates the median retirement savings account balance for all U.S. families stands at $87,000.
What is the smartest age to retire? ›
For people working in knowledge-based jobs, a retirement age in the 70s is reasonable from a cognitive perspective, too, said Lisa Renzi-Hammond, director of the Institute of Gerontology at the University of Georgia. “Our cognitive faculties we're able to maintain, usually, pretty well into our 70s,” she said.
Where do the happiest retirees live? ›
Barnstable, MA is the happiest city to retire to, ranking #1 of all 200 cities we analyzed. It has the highest ranking overall for community well-being, and one of the highest percentages of residents who are 65-plus. The other cities at the top of the list: Naples, FL at #2, and Ann Arbor, MI at #3.
What is the most difficult state to live in? ›
Worst states to live in, according to study by Pink Storage
| State | Overall | Economy |
|---|
| Louisiana | 1 | 1 |
| Tennessee | 2 | 3 |
| Arizona | 3 | 10 |
| South Carolina | 4 | 18 |
6 more rowsMar 18, 2024
According to the Missouri Economic Research and Information Center, the lowest overall costs of living were found in Mississippi, Oklahoma, Kansas, Alabama, and West Virginia: Cheapest states to retire.
Is it better to retire at end of year or mid year? ›
“There is merit in showing people the benefit of retiring midyear, when they haven't yet collected their full annual income,” said Will Pfeifer, a financial professional with GoldBook Financial in Scottsdale, Arizona. “That way they can do a Roth conversion and it might not push them into a higher tax bracket.
When in the tax year is it best to retire? ›
'It's probably best to retire at the start of the tax year for most people,' says Sean McCann, chartered financial planner at NFU Mutual. 'On 6 April you start with a clean slate.
Is it better to collect Social Security at 62 or 67? ›
The earliest age at which most people can take Social Security retirement benefits is typically 62, but those payments are normally reduced because people usually aren't entitled to 100% of their benefits until 67. People who wait until 70 to retire can receive 124% of their benefits.
