Retirees often use the “4% rule” to help estimate a sustainable withdrawal rate from their portfolio to support spending throughout retirement. While this guideline may be helpful, we believe it is too general a rule to apply to any family, especially in light of high inflation and expected portfolio returns. weaker.
Taking current high inflation into account, we expect headline inflation to moderate to a long-term average of 2.4% per year over time (as shown in our capital market assumptions ). However, how inflation moves can impact a financial plan, especially if costs increase earlier in the plan.
To understand the impact of the higher inflationary environment, we compare sustainable withdrawal rates assuming a constant inflation rate of 2.4% to those of market inflation expectations. It’s no surprise that retirees may need to reduce their withdrawals or increase the assets available to spend in their portfolios throughout retirement.
For example, consider a 40-year retirement plan based on the UBS Wealth Way framework; with a longevity strategy portfolio invested according to UBS’s moderate tax-free strategic asset allocations (SAA) with no non-traditional assets, in addition to a three-year liquidity strategy portfolio containing 50% US cash and 50 % US Government Fixed Income Securities.
Without adjusting withdrawals or available assets to account for higher inflation, a portfolio likely begins to run out of capital more quickly; our analysis indicates that a 40-year pension plan could be reduced by 5 years. The good news is that for individuals, the amount of additional wealth they would need today to account for a permanent change in the cost of the goods and services they purchase is relatively modest. On average, an individual would need 2.4 years of additional withdrawals (about 7% more assets) to maintain an 85% probability of success over 40 years. For example, for every $100,000 (inflation-adjusted) an individual plans to withdraw each year for a 40-year retirement, they would need about $3,270,000, or about $240,000 more than before inflation skyrockets.
Even with the market downturn this year, many households have seen their portfolios more than compensate for the increase in wealth needed to maintain their retirement plan. According to the Federal Reserve, since January 2020, the average household has seen its wealth increase by more than 28%, with many retirees capturing part of the 32% increase in the S&P 500 in their 401(k) and investment accounts. personal. Either way, individuals should assess the evolution of their wealth and the impact of inflation on their chances of a successful retirement.
Unfortunately, for retirees who do not have this additional store of wealth, the revised withdrawal rate for the moderate-risk portfolio and a 40-year horizon drops by 0.2 percentage points, from 3.2% to 3 %. This may sound modest but equates to about a 7% reduction in withdrawals to maintain the longevity of their assets regardless of their retirement horizon.
As households value retirement, simple guidelines like the 4% rule are too general to apply to any family, especially in a higher inflationary environment. Households are best served by working with their financial advisor to establish and periodically review a retirement plan that specifically addresses their unique situation, circumstances, spending habits and needs.
When evaluating your retirement plan, you need to consider several general, but interrelated factors specific to your household, including:
1. Years remaining in retirement
2. Asset Allocation
3. Spending habits
4. Acceptable failure rate
Read the full report Will inflation derail my retirement plan? Strategies to make your savings last June 9, 2022.
Main contributor: Dan Scansaroli
This content is a product of the Chief Investment Office of UBS.