My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, February 22, 2021

How much do you need to retire in Canada? (Part 3)

When we last talked about the amount of money you need to retire, we discussed the critical research from Michael Kitces, a pre-eminent retirement expert in the United States. His work looks at the 4% safe withdrawal rule first proposed by William Bengen, which helps investors map out their wealth strategy in retirement.

This week let’s dig deeper by presenting some dissenting opinions on the 4% rule and detailing what the 4% rule actually means. I’ll also offer my suggestions on how to implement the rule into your wealth strategy.

How accurate is the 4% withdrawal rule?

Whenever we hear universal rules about investing, we need to question how universal they truly are.

Fortunately for us, Mr. Bengen himself shares some key fine print. He has suggested that the 4% rule was a creation of the media and that he actually more often than not used 4.5% with his clients. In today’s investment climate, he says, he would use 4.5% or even slightly higher as a rule of thumb. He also says he would increase his equity holdings from 50% to 70% in dividend paying stocks given today’s low interest rates—if they can be purchased at reasonable valuations.

At this juncture, I need to make like an infomercial and disclaim that while Mr. Kitces and others research have shown the 4% withdrawal rule to be safe, there is no guarantee it will apply in the future, especially given the historically low interest rate environment.

In fact, Wade Pfau, who is profiled in my 2014 series and is still at the forefront of retirement planning, says that “the 4% rule does not apply today, as retirees face the lowest interest rate environment we have ever seen. It also was never meant to apply for those who were not willing to hold at least 50% stocks throughout their retirements.” Mr. Pfau suggests a withdrawal rate as low as 2.4% may be appropriate given the low interest rates.

It is interesting to note that Mr. Kitces and Mr. Pfau both agree that a rising equity glidepath in retirement—starting with a lower equity component and increasing equity exposure over time (which is counter intuitive and in contrast to the typical advice that one should decrease equity exposure as you age)—may be beneficial. I will discuss this in greater detail in Part 4 of this series.

While I have no illusion that I am a retirement specialist, my experience with clients and the studies above have made me believe that the 4% rule is a good starting point for your retirement nest egg planning (especially if you are willing to adjust your yearly withdrawal rate in poor markets). In fact, during multiple meetings with clients and their various Investment managers this year, the consensus is almost unanimous that future returns will be lower over the next 10 to 20 years, but in most cases, the expected return of an equity-tilted portfolio is still well above four percent. Again, I caveat, these expected returns by investment managers, may vary from actual results.

My takeaways

  1. Determine to the best of your ability your expected yearly cash requirements in retirement and use the 4% rule to give you an idea where you stand with your retirement planning. If you need $100,000 a year in retirement, the 4% rule says you will require a nest-egg of $2,500,000.
  2. Engage a financial planner to prepare a detailed financial plan. The 4% rule has been proven to be historically accurate, but a detailed personalized plan is always beneficial. Have your financial planner run alternative scenarios using, say, a 3% and 4% withdrawal rate. If you have an investment advisor, see if they will prepare a financial plan free of charge as part of your investment fee. Keep in mind: a report from your investment advisor in some cases may include suggestions for certain products their institution sells.
  3. If you have been retired involuntarily and were only a few years from your planned retirement date, use the 4% rule of thumb to determine what you need to earn to fund your retirement. As noted by Mr. Kitces, he has often found people forced themselves to work longer than needed, and if you can make up some of your missing salary with a part-time job or consulting gig, you may be okay to take “partial” retirement early. Again, I would suggest speaking to a financial planner to tailor your fact situation to your plan.
  4. If you retired voluntarily, consider working part-time or at something you love, to enhance your capital, keep your mind sharp and—at least in my case—your spouse from killing you.
  5. If the markets go down during retirement, always pre-plan what expenses you can reduce (or as Mr. Kitces suggests, consider reducing your inflation-adjusted spending going forward), so that you can reduce your withdrawal rate for a few years.

It has been a crazy last year and many retirement plans have been turned upside down. Whether you have been sideswiped by the topsy-turvy business climate of the pandemic or been one of the lucky ones to thrive, you should still revisit your retirement planning and nest egg objective.

I am going to briefly interrupt our retirement series to bring you a timely post on claiming home office expenses on your 2020 personal tax return during COVID-19. Following that post, I will conclude this series with a quick recap of some of the factors that impact your retirement planning.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

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  1. Kitces also has pointed out that the biggest flaw with a 4% constant dollar withdrawal, is that when backtested using actual returns , in many cases the retiree ends up with multiple millions of unspent money. For those of us with no bequest motives, this would be regarded as a huge failure.

    Dynamic spending strategies seem to make way more sense...

    1. Thx Garth and thx for the link. Dynamic spending strategies can make sense - I am really looking at worst case scenarios, since people tend to look for the downside rather than upside. I would like to think if things are looking rosy early on, people would adjust using some sort of variable withdrawal rate.

  2. What if the 4% dividend income is from the highest quality Canadian companies, such as, banks, utilities, etc. I understand this income is tax free for married couples if they don't have any other income sources. Also, both the dividends and capital have a good (historical) chance of growing over time as well. Seems to be straight forward, but I suspect I'm missing something with this simplistic approach.

    1. Hi Anon:

      The original rule is premised on the returns a 50% equity/50% intermediate fixed income portfolio would provide historically. The rule says to withdraw 4%, not to necessarily earn 4%. In any event, you need to plan based on your personal circumstances and should have a financial plan prepared taking into account those specific circumstances.