One of the most persistent analogies I have heard in my career as a financial adviser is the story of climbing and descending Mount Everest. As the story goes, more climbers perish on the way down the mountain than do climbing up it. We then equate our clients’ wealth journey with that of climbing Mount Everest – spending lots of time and effort to get to the summit of peak financial wealth (i.e., retirement) only to be left with the question, “How am I to descend the mountain safely?”
While many analogies are tired and overdone, this is actually not a bad one. The problem is this: We as an industry have done an awful job at guiding our clients down the mountain with the same degree of care that we provide on the way up.
Until just within the last decade or so, our standard answer for descending the retirement mount has been the venerated “4% Withdrawal Rule,” popularized in the mid-’90s by historical study of withdrawal rates by William Bengen. Although this rule has been regarded as relatively failsafe, many of the assumptions used in its origination are incongruent with many of the assumptions we make for our clients’ retirement roadmap today.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
There is a better way to help clients build an income strategy for retirement, and our clients deserve just that.
3 Alternatives to the 4% Rule for Your Income Plan
Most advisers are already familiar with the concept of probability-based planning using Monte Carlo analysis. The same concept holds true for distribution planning. Although we cannot ensure a given level of income from the portfolio over time, we can reasonably expect the portfolio to provide it in most scenarios.
The task becomes how to actually structure the withdrawals to stay within the acceptable probability of success range. Within this category there are two similar but distinct ways to converting a portfolio into income throughout retirement.
Income Approach No. 1: Dynamic Systematic Withdrawals
The first approach is what is called dynamic systematic withdrawals, or systematic withdrawals with guardrails.
This approach modifies the traditional systematic withdrawal approach by introducing decision rules, or “guardrails,” to determine when and how distributions may increase or decrease over time. These decision rules are set forth at the creation of the plan and inform the decision to reduce withdrawals to accommodate increased risks related to the markets, longevity, inflation or sequence risk.
Some examples of these rules inlcude Jonathan Guyton’s and William Klinger’s decision rules, floor and ceiling rules, and targeted portfolio adjustments. In their study, Guyton and Klinger found that a sound set of decision rules could potentially increase the initial withdrawal rate by as much as 100 basis points.
Who may want to use this method: This approach may be the most appropriate for retirees who are willing to tolerate some fluctuation in their retirement paychecks (subject to some limits, of course) but who want to start out with as high an income as possible.
Income Approach No. 2: Bucketing
The second probability-based philosophy of converting a portfolio into retirement income is called time-segmentation or, more commonly, bucketing. The term “bucketing” has been used and reused to fit a wide set of applications. Within the context of retirement income planning, bucketing refers to the breaking up of retirement into distinct time increments and investing for specific outcomes at specific times. The idea is, if I know I won’t need to touch a sum of money until some specified date in the future, I will be more comfortable riding out fluctuations in the value of that bucket.
A simple way to set up buckets is to separate the portfolio into time segments corresponding with the “Go-Go” years, the “Slow-Go” years, and the No-Go” years of retirement, although there are many ways to achieve the same end using other methods of segmentation. These different time periods in retirement typically represent different spending patterns.
Who may want to use this method: This second approach to retirement income planning may be the most appropriate for retirees who desire more structure in their plan and who would typically need more behavioral coaching along the way using systematic withdrawals. These clients may have a lower-than-average risk tolerance for their age, and they are likely to be more detail-oriented.
Income Approach No. 3: Safety-First Planning
Our third approach to retirement income planning has wide acceptance in the academic community, garnering support from multiple Nobel laureates and a wide array of academic thought leaders. The safety-first approach, also known as the flooring approach, is tied to the academic theory of life-cycle finance. This theory seeks to address the question of how to allocate resources over one’s lifetime so as to maximize lifetime satisfaction, given existing spending constraints.
Put simply, in the safety-first approach you help the client categorize their expenses into needs, wants and wishes. You then create a floor for their needs using pensions, Social Security, bond ladders and income annuities. In this process, it is essential that the financial adviser does not project their own perception of what should be considered needs and/or wants. This should be left entirely up to the client(s), with the adviser as a guide.
Who may want to use this method: This approach lends itself more to individuals and couples who focus more on their cash flow than their wealth and to those couples who are relatively healthy with long expected lifespans.
The Bottom Line on Income Planning
Whichever approach you and your client ultimately decide upon, one thing is inevitable: You will have presented your client with a thoughtful and methodical approach to designing their plan, their way. After all, what good is a Sherpa who guided you all the way to the top of Mount Everest only to tell you he didn’t know how to safely get back down?
-
10 Best High-Yield Savings Accounts to Grow Your Tax RefundIf you're getting a tax refund this year and want to grow it, here are the best high-yield savings accounts to make it happen.
-
TurboTax: Features, Pricing and Filing OptionsIs TurboTax worth it in 2025? Explore the pros, cons, pricing tiers and standout features of this popular tax software to see if it fits your filing needs.
-
Social Security Fairness Act: Five Financial Planning Issues to RevisitMore money as a public-sector retiree is great, but there could be unintended consequences with taxes, Medicare and more if you're not careful.
-
Social Security Warning: Five Missteps Too Many Women MakeClaiming Social Security is complicated, and for women the stakes are high. What you don't know can cost you, so make sure you do know these five things.
-
To Buck the Third-Generation Curse, Focus on the Family StoryThe key is to motivate the next generations to contribute to the family business in a productive way. You can look to Lawrence Welk's family as a prime example.
-
How Roth Accounts Can Ease Your Tax Burden in RetirementStrategic Roth IRA conversions can set you up for tax-free income in retirement and a tax-free inheritance for the people you love.
-
Are You a High Earner But Still Broke? Five Fixes for ThatIf you're a HENRY (a higher earner, not rich yet) but feel like you still live paycheck to paycheck, there are steps you can take to get control of your financial future.
-
Tax Diversification: Smart Ways to Preserve Your Nest EggA long and active retirement may be costly — and may even bump you into a higher tax bracket. Paying some taxes on your savings now could be the answer.
-
How to Thrive in Retirement: Balancing the TradeoffsTo cultivate a happy retirement, you need to tend to it as carefully as you would a flourishing garden, and that means making the right choices for you.
-
Kick the IRS to the Curb in RetirementThat 401(k) or traditional IRA you've filled with your hard-earned money could turn into a tax bomb. Before it blows, see if a Roth could help rescue you.
