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– January 12, 2015

The shift in coverage was expected. When 401(k) plans started gaining traction in the early 1980’s, they were lauded for allowing individuals to control their own finances. What could be more American? With the shift in coverage came newspaper and financial magazine articles propagating two retirement planning guidelines that we challenge in this brief:

1. Once you retire, you should follow a structured withdrawal strategy to optimize your retirement spending. This means you should engineer a plan for how much you will spend from savings each year and try to stick to that plan. This can be a fixed dollar amount, a fixed percentage, or one of several other mechanical strategies.

2. Your investments should be less risky as you approach retirement and should remain generally low-risk throughout retirement.
We challenge these ideas because 401(k) balances for many households are relatively low. For working households aged 55 to 64 (households include married couples, singles, and families) with a defined contribution plan, the median accumulation is $111,000 (Source: Survey of Consumer Finances). Standard retirement planning such as the 4 percent rule suggests this amount could safely provide income of about $4,500 a year. By comparison, the average Social Security benefit for retirees is almost $16,000 per recipient (Source: Social Security Administration). For a married household with a spousal benefit, this equals about $24,000 per year. A two-earner household can expect to receive an average of $32,000 per year from Social Security.

The shift from employer pensions to 401(k)-type plans has increased the worker’s burden of saving for retirement. For many workers nearing retirement, this burden has resulted in savings of less than $200,000, leaving them under-prepared for a retirement that relies on savings. Despite the changing retirement landscape, Social Security and pension income still make up the majority of assets for workers nearing retirement. If you’re one of the millions of Americans nearing retirement and planning to receive most of your retirement income from Social Security and pensions instead of through savings, you may benefit from moving away from traditional retirement planning guidelines.

How Much Have Households Saved?

News articles are usually derived from academic studies that too often focus on households with higher than average savings. The typical academic article, including AIER’s recent research report on retirement drawdown strategies, looks at a household with $1 million in savings, from which it will derive most of its retirement income. Chart 1 reveals that only about 6.5 percent of households approaching retirement with a defined contribution plan have as much as $1 million saved.

The financial news also tends to ignore pension income. Chart 2 shows that about half of households can expect to receive between $30,000 and $50,000 in annual pension income. This brief discusses how ordinary households—those with $200,000 or less in savings and at least $30,000 in expected pension—may want to rethink withdrawal strategies and asset allocation.

A typical accumulation of $100,000 in savings represents about three times a typical $30,000 annual pension. The retirement literature focuses on households with savings that represent at least 10 times the annual pension (e.g., $500,000 savings and $50,000 pension). Chart 3 reveals that this focus limits the audience for this literature to about 15 percent of the population nearing retirement with a defined contribution plan. About 68 percent of these households have retirement savings less than five times the expected annual pension.

We posit that typical workers approaching retirement, those with ratios less than five to one (5:1) in Chart 3, may benefit by discounting the traditional retirement planning guidelines and increasing the risk exposure of their limited financial assets. We explain in the following sections why these households are not likely to find the traditional planning guidelines beneficial or realistic.

Safe Withdrawal Rates

Modern retirement planning starts with an emphasis on safe withdrawal rates and what a retiree can get out of his or her retirement account. Safe withdrawal rates originated in research by William Bengen in 1994. Bengen looked for the rate at which any historical retiree could draw income from a portfolio and have the portfolio last at least 30 years. He found that “assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal of 4 percent, followed by inflation-adjusted withdrawals in subsequent years, should be safe.” This is called the 4 percent rule.

For example, if a retiree has $1,000,000 in retirement savings, Bengen’s work suggests drawing $40,000 (4 percent x $1,000,000) every year in retirement, adjusting for inflation. If inflation jumps 3 percent, he proposes automatically withdrawing $41,200 in the second year. Bengen found that this strategy would historically allow any retirement portfolio to last at least 30 years, a reasonably long period to cover most retirements. Bengen advocated a portfolio allocation of 50 to 75 percent stocks, with the remainder in bonds.

This 4 percent rule is bound by several critical assumptions. First, it assumes a portfolio accumulation of $1 million. Second, it does not consider how pension income might change the retiree risk profile. Third, it seeks a constant annual withdrawal amount (inflation adjusted) and constant equity allocation in the investment portfolio.

The 4 percent rule has persisted in subsequent research. In 1998, “The Trinity Study” found that a 4 percent initial withdrawal rate, followed by annual inflation-adjusted withdrawals of the same dollar amount, is “extremely unlikely to exhaust any portfolio of stocks and bonds.” In addressing asset allocation, the study finds that “most retirees would likely benefit from allocating at least 50 percent to common stocks.” The Trinity Study’s findings on both drawdown percentage and asset allocation confirm the conclusions arrived at in Bengen’s seminal work.

More recently, several studies have sought to determine safe withdrawal rates in today’s economy. These recent studies have largely found that absolutely safe withdrawal rates may actually be below 4 percent. AIER’s research report on retirement drawdown strategies finds that a constant dollar drawdown of 3.5 percent is the maximum constant drawdown percentage that has been historically safe most of the time.

The common element across the 20 years of research discussed above is that it seeks an absolutely safe withdrawal rate, which is somewhere in the vicinity of 3 to 4 percent, inflation adjusted.

Do Safe Withdrawals Improve Your Quality of Life?

Where does the 4 percent rule leave typical workers—those with far less than $1 million in retirement savings as they approach retirement? For a worker who earns $40,000 a year and saves $1 million, the 4 percent rule bodes well, but how many of these people exist? Recent research from the Center for Retirement Research at Boston College suggests that the typical household aged 55 to 64 has only $52,600 total in financial assets (e.g., stocks and bonds), 401(k)s and IRAs. Most retirees have less than $200,000 in savings, which excludes the net worth in home equity, vehicles, and other non-financial assets.

The 4 percent rule and other withdrawal strategies are systematic ways to deplete savings and leave little for long-term unexpected expenses. These strategies may be right for you if that rate of annual spending will improve your quality of life every year. However, if the increased income generated from 4 percent of your savings doesn’t significantly improve your quality of life, you may instead decide on a different approach. For example, you may instead want to spend a portion of savings immediately upon retiring and save a portion for the long-term.

Every household is different, and safe withdrawal rates may appeal to you. Let’s say you have $100,000 in savings and expect to receive $35,000 per year from Social Security. If it is important to you to be able to spend at least $38,000 per year instead of $35,000 per year, traditional retirement planning guidelines are appropriate. A $3,000 annual withdrawal means that you can allocate the portfolio with a conservative tilt toward bonds (e.g., 30 percent stocks and 70 percent bonds) and still expect the money to last for at least 30 years. However, there is little chance of significant savings growth given regular withdrawals.

On the other hand, if your satisfaction changes only incrementally with an annual income of $38,000 instead of $35,000, traditional retirement planning guidelines have limited value. If you can derive nearly as much satisfaction from just the $35,000 annual Social Security benefit, you can continue growing savings for the future. Realistically, you may want the $100,000 bucket of financial assets for either near-term discretionary spending such as vacations, or for long-term health care or bequests. Many retirees may find satisfaction in spending nothing from this bucket and leaving as much as possible for a potential bequest or for increased spending later in life.[1]  This behavior is different from the standard withdrawal models.

Re-Evaluating Your Time Horizon

In the absence of a mechanical withdrawal strategy, you can start by determining how much you want to spend in the near-term versus how much you want to save for the long-term. You may decide you want to take a vacation, buy a new car, or remodel your kitchen in the first three years of retirement. The money needed for these short-term discretionary purchases can be set aside in safe investments such as cash, CDs, money market accounts, or short-term treasuries, all of which will probably return less than 1 percent, but will not significantly drop in value in the face of stock market volatility.

Ideally, all or a portion of your financial savings can be set aside for increased spending down the road, such as the spending that may be associated with long-term health care. If your baseline plan is to spend only guaranteed income each year ($35,000 in our example above), you can plan on leaving financial assets untouched for up to 20 to 30 years. With a long-term investment horizon for this bucket of savings, there is a compelling argument to invest in riskier assets than traditional financial planning guidelines would advise.

Chart 4 looks at the stock allocation in Vanguard’s Target Retirement Funds. For younger workers whose target retirement year is many years away (i.e., 2045) the fund allocates 90 percent of the portfolio to stocks. The stock allocation for a recent retiree is only 40 percent. Target retirement funds such as those offered by Vanguard, Fidelity, Schwab, T. Rowe Price and others automatically reduce stock exposure as the investor approaches the scheduled retirement date. This is what we’ve learned to do from academia, financial planners, and the media. The idea behind these funds is that investors with longer time horizons can weather the short-term shocks associated with high stock allocations.

This allocation guidance is advisable if you plan to use savings as the primary means of retirement income. As you approach retirement, a balanced portfolio of stocks, bonds, and cash will be less susceptible to extreme volatility, which is important when you have short- and medium-term spending plans. But if you are instead planning non-traditional withdrawals, you can set aside short-term discretionary spending and plan to save the rest for the long-term. This means that you may want to disregard this standard asset allocation strategy.

Even in retirement you can allocate your financial assets for the long term. This means a higher allocation toward stocks than would traditionally be advised, maybe even up to 90 percent. By maximizing returns over a 20-year horizon, the portfolio may grow to a level that allows more spending flexibility later in retirement.

Re-Evaluating Your Overall Investment Risk

When evaluating investment risk and asset allocation in retirement, it is important to consider Social Security and pension income, which are both guaranteed assets. Annual pensions and Social Security are not savings per se, but when you convert 30 years of pension and Social Security income into a present value lump sum, you will see that they likely constitute a large share of total assets.

One strategy for approaching retirement planning is to start by writing down which of your assets are “safe” versus which are “risky.” Cash, private pensions, Social Security, and government bonds can generally be considered safe.[2]  Financial assets held in stocks or other investment vehicles are risky.

Safe assets such as pensions and Social Security alter the retiree risk profile. If we use a rough estimate to convert a hypothetical $35,000 annual Social Security income to a lump sum, we get a value of $875,000 ($35,000 divided by 0.04). Combined with a hypothetical $100,000 in 401(k) savings, retirement assets total $975,000.

Let’s say you’ve decided, based on traditional retirement planning advice, to allocate 50 percent of retirement assets to risky assets like stocks and 50 percent to safe assets like bonds. Even if you allocate 100 percent of your $100,000 to stocks, your total retirement assets are still predominantly safe ($875,000 out of $975,000 total assets). And even if you include the value of your home as a risky asset, the majority of your assets are safe.

This method of evaluating overall investment risk suggests maintaining a higher level of exposure to stocks than traditional planning guidelines would suggest.

Research Evidence

We have looked at why a typical retiree may be well-served to ignore the guidelines that suggest mechanical withdrawals and reduced stock exposure in retirement. Until 401(k) plans make up a larger share of retirement income, mechanical withdrawal strategies should be employed by only a minority of Americans: those households that have savings at least 10 times their annual pension. As we have seen, only about 15 percent of households approaching retirement with a defined contribution plan are in such an advantageous financial position. Standard asset allocations may also be of limited benefit when we re-evaluate the time horizon and risk profile in light of alternative spending plans and lower savings amounts.

In fact, traditional retirement planning literature has suggested such a re-evaluation, but you have to read between the lines to find the suggestion. A 2011 Retirement Management Journal article sought ideal withdrawal rates and stock allocations based on two different levels of guaranteed pension income ($20,000 or $65,000). The authors find that people “are willing to become more aggressive in their portfolio distribution strategies” when the ratio of pension income to financial savings rises. In other words, if people have more pension income relative to financial savings, it makes them more willing to take on risk.

In our study, we test and confirm the claim that pension income can affect optimal withdrawal and investment strategies. We estimate a measure of utility, or satisfaction, for various spending amounts and stock allocations. In Table 1, we determine the withdrawal and stock allocations that maximize utility (certainty equivalence) for different levels of savings. In the example, we use a guaranteed pension annual income of $40,000. As savings decrease, a faster withdrawal rate and higher stock allocation maximize utility.

The bottom line is that as savings approach a realistic range of $50,000 to $200,000, the optimal allocation and withdrawal strategies entail high risk. This means the optimal withdrawal amount in our example can be as high as 9.4 percent and the optimal stock allocation can be as high as 100 percent, far higher than most retirees would consider comfortable.

In Practice

So what should you do with all of this information? If you’re lucky enough to have over $1,000,000 in savings for retirement, there is ample literature focusing on spending and allocation strategies. But if you’re in the majority, you’re more likely to have $200,000 or less, which probably represents only a small portion of your total retirement income. How should you plan to spend and invest your financial assets? The truth is that no matter how conservatively or aggressively you invest, your investments are not likely to have a huge impact on your quality of life in retirement. If you are able to set the money aside for the long haul, it would be optimal to invest with the long-term in mind by maintaining a high level of exposure to stocks, perhaps up to 90 percent as suggested by the long-term target date funds.

A sample aggressive portfolio with 90 percent stock allocation might include 10 percent exposure to emerging markets equities, 10 percent exposure to real estate investment trusts (REITs), 20 percent exposure to international equities, 50 percent in domestic equities, and 10 percent in investment grade bonds. Because the literature has repeatedly shown that active management does not improve long-term performance, we suggest index funds that charge low fees in order to get the best long-term, after-fee returns.

This suggestion may be unnerving if you’ve followed the common target date strategy that writers in the financial press have propagated. That advice may have led you to hold less than 50 percent of your portfolio in stocks as you approach retirement. After all, you’ve been told time and again by the media that you need to become more conservative as you approach retirement. Unfortunately, the media has focused on the minority of Americans for whom savings are more critical than pension income.

For those of you who don’t plan to use your limited savings for daily expenses and who will derive your regular income from Social Security and pensions, consider adjusting your retirement plan by taking more risk with long-term savings.


[1]  Retirement plan coverage data from FRB: Survey of Consumer Finances. For full citation details, please see Luke Delorme. 2015. Confirming the Value of Rising Equity Glide Paths: Evidence from a Utility Model, AIER Working Paper 002.


[1]  Tax-advantaged retirement vehicles, such as 401(k) plans, mandate a certain level of distribution after age 70. This is known as the required minimum distribution. For the purposes of the non-traditional retirement planning discussed in this brief, you may be required to withdraw the money, but not to spend it. In other words, the money that is withdrawn can be reinvested in a different vehicle.

[2]  Pension payments are assumed to be inflation-adjusted for the purpose of this article. Social Security is inflation-adjusted based on cost of living adjustments. If your pension plan is not inflation-adjusted, you may want to discount the value of this income source, since inflation will erode the value of the pension over time.

Luke F. Delorme


Luke F. Delorme is Director of Financial Planning for American Investment Services. Articles do not constitute personal investment advice. Please seek the advice of a professional before implementing any financial decision. Luke can be reached at

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