Life expectancy on Canada is going through the roof. For upper-middle-class couples age 65 today, there’s a 43% chance that one or both will survive to at least age 95, according to the Society of Actuaries, which recently updated its mortality tables [Link: www.soa.org] By 2029, the odds of that 65-year-old reaching 95 climb to 50%. Meanwhile, Social Security data, which measures the overall U.S. population, puts the odds for that 65-year old couple reaching 95 at just 19%.
It wasn’t that long ago when financial planners based projections on the premise that a couple’s money had to be capable of supporting a 30-year retirement. That may have been true when people worked until 65 and very few lived past 95. That’s no longer the case.
The new retirement reality
This new retirement reality was highlighted by Wade Pfau, a professor of retirement income at American College in Bryn Mawr, Penn., during a recent seminar. Said professor Pfau: “When it comes to retirement planning, 40 years is becoming the new 30 years for highly educated, higher-income people.”
Professor Pfau’s findings were summarized in detail by Ian McGugan, writing in The Globe and Mail (June 28, 2015), in an article entitled: Longer lifespans demand a rethink of retirement planning. Mr. McGugan observed: “Adding an extra decade to your retirement planning spreadsheet isn’t a big deal if you’re one of the fortunate few with an inflation-protected defined-benefit pension plan. For everyone else, though, a longer retirement means a substantial dollop of added risk.”
The 4% rule
Some retirees plan their retirement strategy using the much quoted 4% rule, which states you can safely withdraw an amount equal to an inflation-adjusted 4% of your initial portfolio each year. But despite the apparent conservatism of the 4% rule, retirees may wind up disappointed if they follow it blindly.
Professor Pfau analyzed a well-known 1998 study by three professors at Trinity University in San Antonio, Tex., that looked at how various withdrawal rates would have worked out for U.S. investors over the preceding decades.
The so-called Trinity Study – for a copy of this treatise, published by the Association for Financial Counseling and Planning Education, go to [Link: afcpe.org] – found a 4% withdrawal rate succeeded in nearly every case – that is, it would have left people with money at the end of a 30-year retirement. But professor Pfau’s new numbers, which include results to the end of 2014, show that even the supposedly safe 4% rule looks questionable for today’s super-sized retirements.
For instance, an investor who stuck to the 4% rule and had a portfolio composed of 25% stocks and 75% bonds would have run out of money more often than not over 40 years.
Over shorter periods, even small differences in withdrawal rates make a big difference. Investors who put half of their money in stocks and half in bonds would always have had money left after 30 years if they stuck to a 4% withdrawal rate.
However, a 5% withdrawal rate would have left them with money only 68% of the time, while a 6% withdrawal rate would have succeeded only 43% of the time.
The impact of ultra-low interest rates
Adds Mr. McGugan: ‘Here’s the kicker: Those downbeat numbers don’t yet reflect the impact of today’s ultra-low interest rates because the most recent 30-year period in professor Pfau’s study began in 1985. If interest rates remain low in years to come, the success rate from even conservative withdrawal strategies is likely to plummet.’
Mr. McGugan quotes professor Pfau again: ‘I think a 3% withdrawal rate is now much more realistic.’ Take a look at the following analysis, which looks at how aggressively a retiree could have withdrawn money from an investment portfolio between 1926 and 2014. Professor Pfau examined different portfolio mixes, different inflation-adjusted withdrawal rates and different time spans.
He then calculated a success rate for each – how often a retiree using a given withdrawal rate would have finished a given time span with money still in his or her portfolio. Here are professor Pfau’s statistical conclusions (Source: Wade Pfau, Link: retirementresearcher.com):
|3% Inflation Adjusted Withdrawal Rates||4% Inflation Adjusted Withdrawal Rates||5% Inflation Adjusted Withdrawal Rates||6% Inflation Adjusted Withdrawal Rates|
|75% Stocks, 25% Bonds|
|50% Stocks, 50% Bonds|
|25% Stocks, 75% Bonds|
Michael Fahy, The Michael Fahy Group, CIBC Wood Gundy, 604-691-7207.