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Rethinking the 4% retirement rule

Nearly one-third of retired Canadians are worried that they'll run out of money over the long term, even though they're generally satisfied with the current quality of retirement, according to a recent study from CIBC.

What's troubling is that most admit they don't really have a plan to help them determine how long their savings will last and how much they can withdraw each year to support their lifestyle.

One rule of thumb assumes that retirees can simply spend up to 4 per cent of their savings annually, adjusted for inflation, without too much trouble.

People are living longer
While this strategy remains the guidepost for many retirees, some analysts are calling it into question -- suggesting it's a recipe for disaster in today's world of longer life expectancies and generally lower returns.

"The 4 per cent rule is a place to start, but not end, how you'll plan to spend your savings in retirement," says Rob Williams, director of income planning at the Schwab Center for Financial Research. "Indeed, no rule of thumb will apply to every situation."

Part of the anxiety comes from whether future returns will look anything like the past. The assumptions used to guide retirement simulations -- the backbone of most online calculators -- are historical averages, which currently include an average return of roughly 9 per cent for stocks, and closer to 5 per cent for intermediate-term government bonds.

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Future returns likely lower
However, these numbers are simply too optimistic, says Wade Pfau, professor of retirement income at the American College, a training centre for financial advisers.

He suggests using average stock returns of no more than 5.5 per cent, with 1.75 per cent for bonds -- a significant difference if you're looking 25 to 30 years ahead.

Strict adherence to the 4 per cent rule also doesn't take into account market volatility and how important investment results are in the early years of retirement, something known as the sequence of returns.

Volatility can hurt
Losses that occur early on in retirement have a much greater impact than those suffered later on. And the damage increases exponentially when you're simultaneously draining your portfolio by making regular withdrawals.

In fact, if you retire into a lousy market and start eating into your money too quickly, your plan could be thrown completely out of whack, leaving you without sufficient time to recover.

That's why, in poor market years, it might be a good idea to hold off a bit on withdrawals, or at least postpone inflation increases.

The truth is, there's really no magic formula that's guaranteed to produce a retirement income that lasts for the rest of your life, warns retired actuary Ken Steiner -- you have to stay on top of things.

"Rather than rely on a set and forget strategy that's supposed to be safe with respect to the risk of outliving one's assets, you need to periodically crunch your numbers based on your situation," he recommends.

Gordon Powers heads up the Affinity Group, a consulting firm focusing on retirement readiness

-- Posted January 9, 2014
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