Thursday, May 7, 2015

When It Comes to Retirement Planning, One Size Does Not Fit All Part 1: The Safe Withdrawal Rate

An involuntary shift is taking place with the gradual extinction of defined benefit pensions: the individual is being thrust unwittingly into the role of retirement planner. As a firm that specializes in retirement planning, we have been cautioning clients for years about the dangers this represents. Foremost among them is the lack of training and education obtained by most who now must depend on themselves to tackle topics as broad as investment management, risk assessment and management, tax planning and economics, to name but a few.

To their credit, several groups have attempted to help fill this void of information including the retirement planning industry, the financial media and academia. But while this effort is in part commendable – after all, some information is better than no information – it is also hazardous. When attempting to educate the broad, general public, assumptions have to be made for the intended audience. And therein lies the problem: we believe retirement planning is a very specific, personalized process. Just like everyone’s fingerprint is unique, so too should be their retirement plan.

However, too many people are taking what are meant to be general “rules of thumb” and accepting them as universal truths. There are two examples that we will address: the safe withdrawal rate and the percentage of working income you need to replace in retirement.

The Safe Withdrawal Rate

The safe withdrawal rate is an academic exercise intended to account for the uncertainty of the markets with the desire for certainty in retirement income. In essence, the research runs thousands of potential future market returns based on historical data and determines how much an individual can withdraw as a percentage of their portfolio and have confidence their income will last their retirement. Today, 4% is widely accepted as the safe withdrawal rate. In other words, if you have a starting retirement portfolio of $1,000,000, you should be able to withdrawal 4% or $40,000 each year, adjusted for inflation.

There are a few issues that most people don’t realize with these studies. First, the confidence is not 100%. If you actually read the research, it is generally between 85-95% confident that the retirement income will last. Second, it is not confidence for an unknown retirement, but a 30-year retirement. What does that mean for those who might find themselves in the 5-15% of the scenarios where the income won’t last? What does that mean for those who might have a retirement that lasts more than 30 years? Those are still risks that most retirees are not comfortable taking.

Even more, the research has changed over time. It was not too long ago that 5% was considered the safe withdrawal rate. And today, there are some researchers who are now challenging that 4% may be too high. For retirees looking for certainty, the safe withdrawal rate falls short.

The Necessity for an Individualized Retirement Plan

At Kemp Harvest Financial Group recommend that everyone have an individualized retirement plan that is designed around their specific circumstances and goals. More importantly, we believe this plan should provide a degree of certainty through the plan design itself, not in general concepts or rules of thumb. When it comes to retirement planning, one size does not fit all.

For more topics like this, check out our radio show “Retirement Plain and Simple” every Saturday morning at 8 on WNPV 1440 AM and like us on Facebook!

If we at Kemp Harvest Financial Group can help you in any way with regard to your financial planning needs, please feel free to contact us.

Photo Credit: Ben Watkin

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Author: Todd Little, CFP®, AIF®

Todd Little is a financial planner with Kemp Harvest Financial.  Todd is a CERTIFIED FINANCIAL PLANNER professional and has a Bachelor of Science degree in Economics from Pennsylvania State University.  Todd is a member of the Financial Planning Association. Additionally, he holds FINRA Series 6, 7 and 63 licenses.  In addition to meeting regularly with clients, Todd works very closely with Mark Kemp and our client service staff to create individual retirement income plans and help our clients navigate the retirement process.