The ‘Bengen Rule’ Comes Into Question

By Cyril Tuohy

InsuranceNewsNet

In 1994, financial advisor William P. Bengen published data on what he deemed the “safe withdrawal” amount that would ensure investors had enough money to last them until they died. In the years since, his research has been widely cited and circulated by industry wonks, advisors and customers, and is considered a benchmark for retirement savings. 

Bengen's 4 percent rule was an answer to a vexing question at that time: How much can I withdraw from my investments so I don’t run out of money during retirement? Bengen’s research found that a “safe withdrawal” was about 4 percent of the starting portfolio value, a number which has “stood the test of time,” he said. 

Bengen raised that “safe withdrawal” percentage by half a percentage point to 4.5 percent in the wake of subsequent research. 

For year,s financial advisors used the 4 percent yardstick to gently steer clients down the retirement glide path. The Bengen Rule eventually became to retirement withdrawals what autopilots have become to airplanes. 

But research out earlier this year from a trio of respected academics has come to challenge the Bengen Rule, saying 4 percent withdrawal is wholly inadequate. 

Whether the Bengen Rule still holds up in such a low interest rate environment and whether planners will shift their strategy has been the talk of the financial advisor community, said advisor Joseph A. Tomlinson, principal of Tomlinson Financial Planning in Greenville, Maine. 

What was the impetus for the challenge to the Bengen Rule? Interest rates are the big culprit. In late 1994, the 10-year Treasury was yielding nearly 8 percent. Late last month, the 10-year Treasury yield stood at 2.48 percent, near record lows. 

With those rock bottom rates where they are today, the Bengen Rule appears to be way off due to the return investors can expect on their assets. 

“In most other countries, sustainable initial withdrawal rates fell below 4 percent,” conclude researchers Michael Finke, Wade D. Pfau and David M. Blanchett. “We find there is nothing inherently safe about the 4 percent rule.” 

The researchers published their findings earlier this year in a paper titled “The 4 Percent Rule Is Not Safe in a Low-Yield World.” 

Bengen, a Massachusetts Institute of Technology-trained aeronautics engineer and principal of Bengen Financial Services, was on vacation and could not be reached for comment. 

Pfau, a professor of retirement income at The American College in Bryn Mawr, Pa.; Finke, a professor and PhD coordinator in the Department of Personal Financial Planning at Texas Tech University in Lubbock, Texas, and Blanchett, head of retirement research at Morningstar Investment Management Finance in Chicago, said the 4 percent rule is in fact due to an anomaly of U.S. historical data. 

“For the data used in William Bengen’s pioneering study on safe withdrawal rates, the average real return on bonds was 2.6 percent,” wrote Pfau and his colleagues, referring to the after-inflation "real" investment yield. “Sustainable retirement withdrawal simulation assumes this real rate of return on bond investments within a portfolio. At the start of 2013, real bond yields are much lower.” 

Pfau recommends a withdrawal rate of around 3 percent given the low interest rate environment, but a 3 percent withdrawal rate over the length of a retirement will also mean needing a nest egg 40 percent bigger to withdraw an equivalent amount of dollars as a 4 percent rate allows. For those saving for retirement in an uncertain economy, gathering assets at that rate is a challenge. 

“In the absence of some added income protection, there is a high likelihood that low yields will require planners to rethink their safety of a traditional investment-based retirement income plan,” Pfau and his colleagues concluded.

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].