Safe Withdrawal Rates

Key Points – Safe Withdrawal Rates

What Is a Safe Withdrawal Rate?
Good Safe Withdrawal Rates Are Dynamic
Breaking Down Spending in Retirement
Four Factors for Changing Safe Withdrawal Rates
19 minutes to read | 38 minutes to listen

Do you remember when William Bengen proclaimed 4% as a safe withdrawal rate? Well, Morningstar is now saying that 3.3% in the new safe withdrawal rate. When it comes to safe withdrawal rates, Dean Barber and Bud Kasper believe that there shouldn’t be a standard for everyone. It should depend on an individual’s financial plan. Learn more from Dean and Bud about safe withdrawal rates and how they factor into financial plans.

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What Is a Safe Withdrawal Rate?

Dean Barber: Thanks so much to everyone who joins us for America’s Wealth Management Show. I’m the host, Dean Barber, along with Bud Kasper. Bud, the Grinch has basically stolen Christmas.

Bud Kasper: Again?!

Dean Barber: Again!

Bud Kasper: What’s an advisor to do?

Dean Barber: Oh my goodness.

Bud Kasper: What’s a retiree to do?

Dean Barber: If you go by rule of thumb kind of planning, which a lot of people do because they don’t have the sophistication that we do as CERTIFIED FINANCIAL PLANNER™ professionals, they’re going to read some articles that they find.

If you were to Google, “What is a safe withdrawal rate?” there are at least a dozen articles that will say that the 4% rule for retirement. That has been around now since 1994 and probably isn’t safe anymore. Morningstar is saying that you need to now take that portfolio withdrawal rate down to 3.3%.

What Do the Grinch and Safe Withdrawal Rates Have in Common?

The reason I say the Grinch stole Christmas was because if somebody was planning on retiring—let’s say on January 1—and they follow this rule of thumb, they’re realizing that they would have 20% less income than they were counting on from their portfolio. They think they can’t live on that.

By the way, there’s this little thing called inflation that has been rearing its ugly head lately. Things have gotten a lot more expensive. Those who are following the 3.3% safe withdrawal rate suggested by Morningstar are second-guessing when they’ll retire. People will read these articles and change their lives and their plans based on this information. It is way too basic for that to be the way to make their decision.

How the Idea of the 4% Safe Withdrawal Rate Originated

Bud Kasper: I totally agree. I’m glad that you related back to William Bengen, who created the 4% rule. It was well thought out at the time in 1994. He looked over every 30-year rolling period from 1926 to 1994 in a portfolio that was 50% bonds and 50% stocks. Bengen found that to be the safe distribution rate.

It was a beautiful rule to work with, but then you don’t take into consideration that there are certain times specific to any timeframe that would end up hurting from the perspective of if stocks are up or down. There are so many moving parts associated with that. It’s incumbent upon us as CERTIFIED FINANCIAL PLANNER™ professionals to look beyond the existence of what that rule meant at the time that it was created.

A 3.3% “Safe” Withdrawal Rate Isn’t Safe at All for Some People

Dean Barber: I’m going to tell a couple of quick stories. Oftentimes, our clients rely on us to tell them how much money is OK to spend. I have a client who just turned 75 who has been retired for 15 years. She’s in remission for cancer. Her health isn’t the best, but she’s taking out a withdrawal rate of about 5%.

When I was talking to her last week, I asked how she was doing health wise and then how things were going for her financially. Her doctor said her health was good, so she hopes she has another 10 years or so. However, her drug prices have skyrocketed. She has all these other inflationary pressures that are hitting her. So, she canceled the vacation she was going to take next year.

She didn’t think she could afford it, but I showed her she could. She has no children. Her brother is going to be her sole beneficiary and has more money than she does. Her brother and his wife aren’t spending everything that they have, so her money wasn’t going to go anywhere once she passes on.

I went through a scenario with her where she increases her income by $1,000 a month. I asked her if that would make a difference for her, and she said it would be a life changer. If we increase the withdrawal rate by $1,000 a month, multiply that by 15 years, and made zero return, she was still going to have $250,000 when she dies. That made her day, so she wanted to do it.

If we used this whole idea of following a 3.3% withdrawal rate as a new rule of thumb, this poor lady would’ve sat there and done nothing at home because she couldn’t afford to do anything.

Good Safe Withdrawal Rates Are Dynamic

Bud Kasper: Of course. I want to go back to what Bill Bengen said. There was a conversation I had with him earlier in my career because this 4% rule was fascinating to me. I wanted to understand the math. At that time, I was probably too naive to fully comprehend all the nuances associated with market and interest rate fluctuations, inflation, and the things that we innately put into creating comprehensive plans for our clients.

Bengen recently said the worst-case scenario is now 4.7%. It was 4%, now 4.7%. Morningstar says, no, no, no. It’s 3.3%. Which is right?

Dean Barber: The answer is none of the above. It’s not 4.7%, 4%, or 3.3%. It’s dynamic.

I mentioned earlier that the Grinch stole Christmas again. When I say that, I’m not referencing the Grinch as being the Omicron variant of COVID-19. I’m talking about this Morningstar article from November that has been discussed in major publications nationwide. That article is telling people that the 4% withdrawal rule for retirees is now the 3.3% rule.

People who are planning on retiring in January and anticipate withdrawing 4%, if you’re using simple planning and math, you’re going to think that you can’t retire now because that’s 20% less than what you planned on spending. That won’t work and you then need to work a few more years.

A Fixed Withdrawal Rate Doesn’t Make Any Sense

Bud Kasper: Articles are interesting. We read them constantly because we’re always seeking out more information to make sure we can vet it through our own programs to validate how much is a reasonable withdrawal rate. However, I think it’s silly to get tied down to a fixed withdrawal rate.

Dean Barber: It doesn’t make any sense. The bottom line is that you’ve been doing this for 38 years. I can’t even remember how long I’ve been doing this.

Bud Kasper: 35 years.

Dean Barber: Yeah. So, think about this. How many clients have you had over your career that retire at 60, envision a 30-year retirement, live happy and healthy lives, ask for an annual raise, and keep spending more all the way up to the end of their life? It’s never happened to me because people don’t spend that way.

Bud Kasper: We live in the present, not necessarily in all the numbers. The numbers do support what people need to understand about the math surrounding retirement.

Dean Barber: That’s all looking at it in a vacuum and taking all the other planning components out of it.

Bud Kasper: Inflation and taxes.

Breaking Down Spending in Retirement

Dean Barber: When do you spend the most money in retirement?

Bud Kasper: Hopefully at the beginning of your retirement.

Dean Barber: Maybe for the first 15 years or so. When you get up into your late 70s, early 80s, you start spending less because you don’t feel like going all these places and doing all these things. People have watched their parents and grandparents do it and have maybe done it themselves.

The reason why we created the Guided Retirement System™ is because we know that we’re going to spend more money in those early years. Throw this 3.3%, 4%, 4.7%, or whatever it is out the window. Your plan will tell you how much is safe to withdraw based on everything you want to do.

The Flexible Spending Approach

Bud Kasper: We call that a flexible spending approach. It is real life when you’re dealing with it that way. You’re so right with that because of the other factors that must be taking place like taxes and inflation. There is one thing that I think triggered the reason this article came out when it did. That is equity stocks. They are at all-time highs and yields are approaching all-time lows.

Bonds aren’t the only option that we have for income. Look at that component and say, “Yields are so low, I’m not going to make hardly any money. The stock market is so high, I could end up losing money because it’s going to correct or have a bear market at some particular point in time.” I can’t win in this scenario.

Dean Barber: There was an article out just last week that I chuckled at. It said if you’re thinking about retiring right now, don’t do it. The article explained that this is the worst possible time you could ever retire. Who are these people to say something like that?

Bud Kasper: Fearmongers.

Beware of Those Fearmonger Advisors

Dean Barber: I want to tell another story about a couple who was referred to me. One our CFP® professional teams get on Zoom calls with them because they live out of town. We started talking about their situation to figure out what is going on with them. They are going to be 58 and 55 next year and want to retire.

They want to be completely retired but were frustrated because they went to a local advisor who told them that they would be broke by 85 if they retired now and spent how they were planning to. That advisor that told them they would probably need to work at least another four or five years. They have young grandkids that they want to spend time with and other hobbies and interests they want to do, so they really want to retire.

I asked them if the advisor did any kind of maximization of Social Security. They said he didn’t even ask about Social Security. I asked them if he did any kind of tax planning and projections on how they can reduce their tax liability over time to help increase what they get to take home.

Bud Kasper: Medicare planning.

Dean Barber: Right. That advisor didn’t talk about any of that. All he did was ask how much money they had and how much they wanted to spend. That was it.

Bud Kasper: That’s the problem with the industry. There are people that are passing themselves off as retirement advisors, but they aren’t credentialed. They don’t understand exactly what the planning process is. It’s always solving the same thing—investments and distribution.

The Grinch Tried to Steal Christmas, But Santa Dean Delivered a Great Gift

Dean Barber: I’ll finish my story here. We gathered the information like we would to complete a plan using our Guided Retirement System™. It showed a 95% probability of success that they could spend exactly what they want to spend after taxes and keeping up with inflation. They wouldn’t ever need to adjust their spending 95% of the time. They would never run out of money.

We did tax planning and looked at Social Security integration and Social Security maximization strategies. We also looked at what the legacy goal was, college funding, how often were vehicles going to be replaced, mortgage, and all other aspects of their financial life to create the plan so they could retire in January.

Bud Kasper: Good for them.

Dean Barber: The Grinch tried to steal their Christmas, but I gave them a great gift.

You Retirement Needs to Be in an Intelligent Advisor’s Hands

Bud Kasper: Good for you. If you don’t have the insight into this, you are bound to think that an advisor like that is a nice person. It’s easy to think that they have your best interest at heart with what they’re sharing. That could be the case, but remember, they’re restricted to what they know. Or as we used to say, you don’t know what you don’t know. That person didn’t know nearly enough to make an intelligent decision. It was a critical decision because we’re talking about someone’s retirement.

Dean Barber: Since both these people are under 59.5, the advisor had told them that they had to encumber their accounts with this IRS code 72(t) rule to get any income from their 401(k)s. That rule basically says that whatever you take out must continue for a minimum of five years or until you reach 59.5—whichever is longer.

Bud Kasper: The exact amount with no alterations.

Dean Barber: Zero alterations. If you alter it once by a dollar, the entire amount becomes subject to 10% penalty. I quickly told them they didn’t have to do that.

There’s also a rule in the IRS code that says if you separate service from your employer after age 55, you can access the funds in your 401(k) without a 10% penalty. The advisor didn’t talk to them about that.

Finding the Right Safe Withdrawal Rates Through the Guided Retirement System™

We have CERTIFIED FINANCIAL PLANNER™ professionals and CPAs that work together. We need to know everything about the tax code and understand financial planning to such a degree where we can make people’s lives better.

Bud mentioned something earlier about markets being at all-time highs. There are two videos that I encourage people to watch that relate to that. One is Retiring at Market Highs, and the other is Retiring with $1 Million. If you ever wondered how much you could spend if you retired with $1 million, $1.5 million, $2 million, $3 million—however much money you have—you can get the answers to what is safe to spend. It’s not going to be this 3.3% withdrawal.

Bud Kasper: Because of the limitations of the advisor that they were working with in the story you told, that couple could have ended up hurting themselves in terms of the longevity of their retirement.

Dean Barber: No doubt. Think about the sacrifice of the working another five years and not doing what they really want to do. The Guided Retirement System that we have in place is designed to prevent that type of thing from happening.

Morningstar’s Safe Withdrawal Rates Through the Decades

Dean Barber: In the Morningstar article, they say that the safe withdrawal rate has ranged from 3.5% to 6% over the last three decades. We know that’s a range, but there are times when you might have a year or two that you’re going to spend more than that.

Remember the story I was talking about earlier? In the first few years prior to Social Security, and because they wanted to spend a little bit more in their early years, their withdrawal rate was 5.8%. When we put their entire plan with what they were going to spend when and when the mortgage was going to be paid off, etc., they had a 95% probability of success at a 5.8% withdrawal rate in the first few years of retirement. It’s crucial to plan for that and make sure you have the right allocations.

You don’t want to have 100% of your money in the stock market. If the market goes down and you spend money out of it, suddenly that 5.8% withdrawal stream can be a lot bigger than that. Set aside a chunk of money to make the distributions from in something that is far less volatile that can still get a reasonable rate of return.

Bud Kasper: That’s right. Morningstar estimates that the standard rule of thumb should be lowered to 3.3% from 4%. Bill Bengen, who created the first real understanding of 30 years of continuous history associated with markets, said in 1994 that a 4% rate was the appropriate rate and most financial planners have used that for a considerable period. He’s now saying that it’s 4.7%.

Four Factors for Changing Safe Withdrawal Rates

How can this be such a stretch between these two numbers? There are three interesting facts that are associated with this.

A time horizon that exceeds most retirees’ lifespan is one of the things that we must understand. People are living longer. If that’s the case, you need to vet the plan against living longer. That’s what we do.
Fully adjust all withdrawals for the effects of inflation. Boy, we know that. We’re going to see that as we continue through this period. That’s going to be an important factor.
Have a fixed income withdrawal schedule that doesn’t react to changes in investment markets, meaning performance numbers. You need to readjust your portfolio from time to time to accommodate what we need to make the plan more successful.
A high projected success rate of 90%. When we do planning, one of the things in the outcome is the percent of success that we would have as a retiree under the considerations of all the detailed planning that Dean and I have talked about. The reality is that it should work from that perspective.

We’re using a deterministic historical approach with these numbers that we’re throwing out and everything we’re discussing about Bengen’s thoughts. We must determine the best solution for us every year. If you put all your money in stocks over a longer period, you’re going to succeed. However, it’s the in-betweens that can be critical or that could ruin a retirement. That’s why we go through this much detail as we do in the entire retirement planning process.

Five Good Financial Planning Techniques from Morningstar

Dean Barber: I want to back up to an article that you and I both loved that was published several years ago. Ironically, it was an article from Morningstar by Paul Kaplan and David Blanchett, who wrote Alpha, Beta, and Now … Gamma.

There were five different financial planning techniques that they wrote about in that article. By applying those techniques, a retiree could increase their spendable income by as much as 26%. That in turn took that 4% rule over 5%. If we get 26% more on 3.3%, we’re still above 4%.

However, that still misses the point of a lot of the different things that we’ll do. Let me give an example. Bud and I worked with clients over the last year or two that had a 60-40 stocks to bonds allocation. Guess what? That’s not 60-40 anymore.

It’s either 70-30 or 75-25 because stocks have way outperformed what fixed income has done. Then, the question is, what happened to your portfolio? If you had a 60-40 portfolio, you’re probably positive for the year somewhere in the 13% to 15% range depending upon the mix of equities that you had.

Don’t Be Greedy … Harvesting Is a Good Thing

If we know that our portfolio needs to make, let’s say 5%, to give us the income that we want, what do you do when you rebalance? You take the extra money that you made this year, and now you have three years of distributions that you made in one year. Suddenly, we get a longer time horizon before we need to start tapping that portfolio for withdrawals.

However, people get greedy. They say, “Why would I take that out and set it aside? Look at how much money I’m making in the market right now.”

OK. What do we want to do? Do we want to make sure that you have a secure long-term retirement that you can spend what you want to spend year after year, decade after decade and still leave a legacy? Or are we concerned about what the portfolio value could have been had we left that money in the market for another year or two?

Bud Kasper: You bring up an excellent point. People need to realize that we sometimes fall victim to what the press is telling us and what we should or should not be doing.

What you just pointed out was harvesting. If you had a great year last year and got way above your target for your plan to be successful, let’s keep that. Let’s harvest it and put it in a position so it will support future income needs rather than exposing it back into more stocks. This is a gambler’s biggest problem. The wins could get taken away.

A Dynamic Withdrawal Strategy

Dean Barber: That’s right. We call that a dynamic withdrawal strategy. We know we’re going to need money to live on in the next few years, so let’s harvest the gains that we’ve made this year. Let’s set them aside and there’s our income. Fluctuations in the market over the next three years suddenly don’t matter.

Bud Kasper: They don’t matter because you know we’re always going to have some fluctuation. We’re all going to have changes in inflation. We are also going to have changes in the gosh darn tax laws.

Dean Barber: Yeah. You can you say that again.

Bud Kasper: I guess what we’re saying is the Guided Retirement System™ takes all these elements into play. We know this from a lot of planning experience. The only way to know whether you’re going to have success in retirement is through this comprehensive approach.

Dean Barber: It takes work. It’s not just work on our part. There’s a lot of work for our prospective clients. When they come in and see what this system does, there’s a lot of work on their part as well.

The Art of Financial Planning

Bud Kasper: But you know what? People feel good about it. Yes, it’s laborious, but once you get it out, we can put the puzzle together. Remember what our friend Bruce Godke likes to say, “The only way to get the puzzle together is to look at the picture on the box.” That’s exactly what planning is about.

Dean Barber: That really is at the heart of financial planning. The art of financial planning is understanding what you want your retirement life to look like. If we can get that picture, then we use our skills and our tools to make that picture into reality.

Look, the Grinch didn’t really steal Christmas unless you fail to plan. If you plan and follow the art of financial planning, you can still retire.

Education Is Key to Living Your One Best Financial Life

Financial planning is always a hot topic on America’s Wealth Management Show. It’s the longest-running financial education show in Kansas City. We’re on the air in a lot of other parts of the country, too, but Kansas City is our home. Bud and I are proud of that. We’ve been providing advice for a long time.

And, of course, we’ve gotten a lot better at getting a lot more content out to people. One thing we do on a very regular basis is provide education through newsletters, economic updates, and those types of things. We encourage you to sign up for those. We do educational webinars every other week as well. There is also a ton of literature that we have on retirement planning and how to do it right.

Even if you’re a do-it-yourselfer, I hope you’ll peruse through our videos and articles to educate yourself. The highly-educated people heading into retirement will be safe from what I call the financial predators, the financial salespeople that are out there.

If you’re not educated and don’t know what’s going on, it’s hard to know what the motive is of these financial salespeople. Oftentimes, they are purely interested in how much commission they can earn on a transaction. Those financial salespeople can take advantage of you.

The Industry Needs More Comprehensive Financial Planners

Bud Kasper: That’s the whole point. We don’t have any product to sell. All that we are selling, if you want to think of it that way, is a process. We’re talking about doing some comprehensive financial planning that of those financial salespeople have no degree of expertise in. They might take a pinch of this and a pinch of that, but they don’t have it in a format. There are a few other firms like us, and we’re happy to have them out there.

Dean Barber: Absolutely. The industry needs them.

Bud Kasper: You can always tell where the motivation is by where the commercials. People are smart. They need to understand the process associated with buying an annuity. Nothing, give me your money. That’s all you want to do.

Trust the Financial Planning Process

Dean Barber: I just wanted to make that point because it is a process. It was all the way back in the mid-2000s when Bud and I began to study with Ed Slott. He wrote a book way back when called, The Retirement Savings Time Bomb and How to Diffuse It. Ed just updated that by publishing, The New Retirement Savings Time Bomb: How to Take Financial Control, Avoid Unnecessary Taxes, and Combat the Latest Threats to Your Retirement Savings. He’s got other books as well.

Ed has appeared several times on our podcast, The Guided Retirement Show™. You can get some great information from Ed on the following podcast episodes.

How Modern Wealth Management Was Built

It was then when Bud and I decided to hire in-house CPAs. They are critical to the tax planning component of financial planning. We both struggled for years trying to work with other CPAs that weren’t planners. Those people were tax preparers, but they didn’t understand the concepts of financial planning.

We brought in CPAs and trained them on what the financial planning process looks at and what the tax planning process is within that. We started to apply that and now have five CPAs. We’ve got 12 CERTIFIED FINANCIAL PLANNER™ professionals and a great support staff. Everything is designed to work with those people who have questions such as:

Do I have enough money?
How much is safe to spend?
What can I do?
What is my retirement going to look like?

That’s exactly where our focus is 24/7. There’s not a day goes by that I’m not thinking about how we can improve, evolve, and adapt to new investment vehicles and changes in the economy, tax code, and much more.

Bud Kasper: The partnership between our CFP® professionals inside the firm and our CPAs brings a consummate level of expertise that is unmatchable in most formats of retirement planners. Once we started that, I was brought up to speed on the extreme importance of what good tax planning can do.

Tax Planning Is a Component of the Overall Financial Plan

There are a lot of CPAs that most certainly have the intelligence to do planning. However, many of them are bogged down just from doing tax returns. The purpose of our deal was to bring in the CPAs from a planning perspective. We do tax returns for our clients as well, but it’s the planning integration of these two professions that make it really sound.

Dean Barber: The interesting thing is that you can’t do tax planning without first having a comprehensive financial plan in place.

Bud Kasper: Good point.

Dean Barber: That’s why most CPAs don’t do tax planning. They’re not working with a CFP® professional that has already created the comprehensive financial plan for them to start applying all the tax planning techniques. That’s where we saw the big missing link.

Back in the mid-2000s, we brought that all in-house. We needed to have the CPA sitting right next to the CFP® professional and the client to do the hard planning work. What’s more, we’re planning in advance to meetings with the client.

We’re just about to finish all our tax planning for our clients—not for 2021, but for 2022, 2023, 2024, and beyond. We know that if you do that forward-looking tax planning, you have the unique ability during retirement to control your taxes unlike during those working years.

Just Like Santa’s Elves, Our CFP® Professionals Are Working Full Speed Ahead During the Holiday Season

Bud Kasper: That’s so true. We are busier than ever right now. I’ll be so glad to get Christmas behind us only from the perspective of we’re doing all this preparation work. We’re making adjustments for the tax year coming up. We’re doing Roth conversions, which is almost stretching what we can produce because of the volume that we’re dealing with now. I think we had three CPAs last year. Now we have five and we’re probably going to have some more, right?

Dean Barber: Absolutely. We need to because there’s a level of work that must be done.

Bud Kasper: We don’t know anybody that doesn’t need it.

Dean Barber: Exactly. There are many people who are do-it-yourselfers when it comes to their investments, which is fine. If you are one of those people but would like to have us do your financial planning and your tax planning, you can hire us for a fee to do that.

We have many people that will do that. If you’re a do-it-yourselfer on investments, one thing to keep in mind is whether your significant other has the expertise to carry that on if something happens to you.

If not, it’s great to form a relationship with a firm like ours so that we can understand your process. So, if something were to happen to you, we can take over for your surviving spouse.

Bud Kasper: There’s a vulnerability at the point of the loss of the first spouse, usually the man, and now all this stress is placed on the surviving wife. The last thing you want happening is her being so stressed out that she can’t make right decisions. If you have a plan in place, you won’t have that concern.

The Great Gift of Financial Planning

Dean Barber: That’s right. Well, I started our conversation of a funny note saying the Grinch stole Christmas. The truth, though, is that financial planning has never been more important. With good financial planning, you can accomplish the things that you want to accomplish and do it in a way that brings you a lot of clarity.

We appreciate everyone who joins us on America’s Wealth Management Show. I’m Dean Barber along with Bud Kasper. We’ll be back with you next week same time, same place.

You can schedule a complimentary consultation with one of our CERTIFIED FINANCIAL PLANNER™ Professionals by reviewing our calendar. We’re available to meet with you in person, by phone, or during a virtual meeting.

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.