FA Playbook

Rethinking the 4% withdrawal rule

Jennifer Woods, Special to CNBC.com
What you take out depends on what you put in

You've spent decades socking away money in your 401(k) and IRA, with the prospect of a comfortable retirement looming on the horizon. Now that you're at or nearing retirement, the million-dollar question is: Will it be enough?

The greatest fear people have around retirement is outliving their money and not having enough to meet basic needs.

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The answer has always been a simple one: It was a generally accepted axiom that 4 percent is the amount you can safely withdraw annually from a 401(k), individual retirement account or other retirement savings while still maintaining a reliable, lifelong retirement income.

While this "4 percent drawdown rule" remains the gold standard for many financial advisors and their retiree clients, some have called it into question—or even believe it's a recipe for disaster in today's world of longer life expectancies and lower yields.

Even Bill Bengen himself, who nearly 20 years ago released the groundbreaking research demonstrating that 4 percent is a sustainable withdrawal rate in retirement, isn't convinced the rule still applies, given the current economic environment.

When Bengen, a certified financial planner and president of Bengen Financial Services, first recommended the 4 percent drawdown in a 1994 Journal of Financial Planning article, it was based on a "worst case" scenario of an investor who retired in 1969.

"The question now is: 'Are we going to have a worse environment than the 1969 retiree or not?' " he said. "I honestly don't know. I won't know, for sure, for some years, until we see what type of investment environment we go through."

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For his part, Seth Stewart, president of PlanMyBenefit and managing partner at Brookstone Financial, believes following a 4 percent drawdown rule is risky.

"I think that it's nonsense," Stewart said. "I don't think you can count on it. It's an easy way to plan, but if there is another market correction, someone who retires this year and doesn't have enough cash in their accounts will be forced to sell low to generate that income."

And if the market encounters a sequence of negative returns, Stewart said, the 4 percent approach "could be devastating."

Saul Simon, a certified financial planner at Simon Financial Group and author of "Simon Says Love your Legacy," also questions the validity of using a 4 percent drawdown across the board.

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"There's been some analysis that says if you use a 4 percent distribution rate you'll never run out of money," he said. "But that's not necessarily true or guaranteed."

Now, with interest rates being so low, some economists are recommending the drawdown rate should, in fact, be 3 percent, to give people the comfort and peace of mind that they won't run out of money, Simon said.

However, because financial planning is more of an art than a science, "the [drawdown] rate should really be different based on every person," he noted.

It may seem obvious, but it's key that retirees not withdraw more than they can afford. Yet some clients do, despite his warnings, Simon said.

"I have clients who are withdrawing 10 percent of their money on an annual basis," he said. "For a couple of years—even though I told them it wasn't healthy—they saw that the markets were producing 10 percent-plus returns, and they were taking money out because of the earnings."

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While advisors urge their clients to maintain some level of discipline in their spending, sometimes it can be a lost cause.

"Human beings like to live for today. They have a lifestyle that they want to maintain," Simon said.

Stewart added that some advisors are even turning away prospective clients who have been drawing down their retirement funds at rates higher than they can afford.

Those clients "create substantial risk for the advisors," he said. "There is a certain responsibility as an advisor to set realistic expectations."

Despite the naysayers, there are advisors who still see merit in the 4 percent rule.

"Even if we expect lower returns in the future, [the 4 percent drawdown] is still a good rule of thumb," said Lisa Fox, a certified financial planner and executive vice president and director of financial planning with South Texas Money Management.

She did, however, acknowledge that there needs to be room for flexibility.

In bad market years, for instance, it's a good idea to lower the rate to 3 percent, Fox said, or to start at 4 percent and postpone inflation increases for several years, as some of her clients now do.

(Read more: Don't go it alone with 401(k) plan)

Additionally, a very conservative portfolio may warrant a lower withdrawal rate, she noted. The success of a 4 percent drawdown is based on a 60 percent stock and 40 percent fixed-income allocation, Fox said. That concept was popularized in the 1990s, when markets were roaring.

The 60/40 formula is optimal for people entering retirement, she said. But for clients who insist on a more conservative allocation, Fox believes a 3 percent withdrawal would be more appropriate.

While advisors may debate various withdrawal rates, one thing they all agree on is that the rate, in general, is a key factor in determining how long retirement savings will last.

But it's not the only factor. To create a solid retirement plan that will ensure someone's money won't run out during their lifetime, there are various strategies and guidelines that financial advisors say are essential to follow.

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For instance, advisors stress that clients should create and follow a realistic budget; understand and manage health-care costs; take into account personal and economic changes to ensure their financial plan is still on track; and maintain an emergency fund.

In fact, some experts recommend that retirees have a year's worth of living expenses in that emergency fund, so that—whatever happens in the market—their disposable income is not affected.

—By Jennifer Woods, Special to CNBC.com.