How much we can safely spend each month from our savings during retirement can be an emotional subject. People want more income, but they also want to know that they won’t run out of money. The truth on this subject can be very unwelcome. Financial advisors seem to feel this pressure from their clients because advisors often seek ways to argue that higher withdrawal rates are possible. I give a couple of examples here.
Most people whose lifestyles are not fully covered by CPP and OAS payments have not saved enough to cover the difference over a long retirement. Either their lifestyles must become less expensive or they will drain their savings too fast. These people don’t want to hear that their withdrawal rates are unsustainable.
People seek reasons to believe that they can exceed the well-known 4% rule when the reality is that this rule is overly optimistic because it is based on zero investment fees. In truth, a 3% rule is closer to the mark for a long retirement.
Among reasonable people I discuss finances with, one of the most unwelcome observations I make is that the 4% spending rule in retirement is often too aggressive. In a world where so many people would like to quit working but have less saved than they’d need, there is a strong emotional need to believe it’s possible to generate a high income from savings.
Financial planner Wes Moss uses a 5% rule that he justifies by investing in stocks with high dividend yields and then hoping they produce the same capital gains as other stocks with lower dividends. This shouldn’t be very persuasive, but consider it from the point of view of someone who hasn’t saved enough. Suppose you’re retired at 60 and desperately want to spend $5000 per month, but the 4% rule gives you only $3000 per month. Moss says you can have $3750 and I say that only $2250 is safe. I’m pretty sure most people would listen to Moss and push me out the door.
Even David Toyne, Director of Business Development at the very client-friendly firm Steadyhand isn’t immune to the pressure to allow higher income. In an otherwise useful and informative video interview, Toyne said the following at about the 11-minute mark:
“In retirement you can withdraw 4% of your portfolio and that’s a sustainable withdrawal rate—in other words you won’t run out of money—remember that 4% could be 5% if you trim your fee by 1%.” I’m all for cutting fees, but the 4% rule is based on zero fees. Cutting fees might boost your safe withdrawal rate from 3% to 3.5%, but it won’t get you to 5%.
A justification I hear for higher spending levels is that people tend to spend less as they age. This is almost certainly true, but it is largely because people spend less as they see they’re running out of money. A study examining this question produced data supporting this conclusion. People begin to reduce spending, even in their 60s, if their spending is high relative to their savings. But people whose spending is in line with their savings don’t spend less as they age.
I’m not a lone voice on this point. Jeff Brown makes a case for something closer to a 3% rule, and William Bernstein is quoted as saying “Two percent is bullet-proof, 3% is probably safe, 4% is pushing it and, at 5%, you're eating Alpo in your old age.”
Because their clients want to hear they can safely spend more, even some good advisors want to believe that higher withdrawal rates are safe.