Four on the Floor

With clients routinely living 25 to 30 years into retirement—or more—advisors must significantly rethink their planning horizons.

By Guy Baker

Key Takeaways:

  • At the core of retirement planning, three questions must be answered: How much does a client need to maintain a reasonable lifestyle? How much should be saved to get there? How much can be reasonably withdrawn from investment accounts each year?
  • The long-standing four percent drawdown rule may no longer be a viable benchmark.
  • Advisors must be able to help retirees manage three types of risk as they age: investment and portfolio risk, consumption and inflation risk, and, finally, mortality and longevity risk.

The American College recently launched a doctoral program in retirement planning. This program was designed to help academicians and practitioners alike look more closely at the coming retirement crisis and help identify possible solutions. Much has been written in the past couple of years regarding the new thinking that has emerged regarding safe withdrawal rates and floor income.

At the core of retirement planning are three key questions:

  • First, how much capital is needed at retirement in order to maintain a reasonable lifestyle until death?
  • Second, how much should be saved to reach this goal?
  • Third, how much can be reasonably withdrawn from an investment account to sustain this lifestyle without running the risk of depleting the investment portfolio?

Embedded in these questions are issues of significant importance. Without a keen understanding of these issues and their ramifications, advisors run the risk of actually causing clients to make poor decisions that will not be discovered until it is potentially too late. This is an outcome no professional advisor would willingly want. Yet the potential is there for advisors to lull retirees into a false state of security and ambivalence from which they might never recover.

Is the four percent drawdown rule still viable?

At the core of this problem is the four percent rule first proposed in 1994 by William Bengen, CFP. His historical analysis of rolling returns concluded investors could withdraw an inflation-adjusted four percent annually from their portfolios with impunity. This became the benchmark for distribution planning for nearly two decades. It took the lost decade (2000 to 2009) for advisors to realize that markets are dangerous to a retiree’s wealth. Dr. Moshe Milevsky, Dr. Wade Pfau and other researchers, using Monte Carlo simulations, have questioned whether this conclusion is as bulletproof as once thought. Their research and modeling show a high probability of failure due to “sequence risk”—the unfortunate cycle of down markets, which if it hits in the first six years of retirement, there is virtually no recovery.

As advisors, how much responsibility should we take for an unsuccessful outcome from our recommendations? Do advisors owe a higher level of due care to help clients protect themselves from market aberrations that potentially could relegate them to poverty in their last decade of life? What methods should be used to set up early warning signals that failure is imminent? And if it is, what should be the bailout strategy to prevent total financial ruin?

Three phases of retirement and risk factors

The investor life cycle has essentially three phases: accumulation, transition and decumulation. In each phase, advisors must be aware of how these risks will impact their recommendations: investment and portfolio risk, consumption and inflation risk, and finally, mortality and longevity risk. Early models for retirement planning treated all three phases the same. Additionally, there was little thought given to whether the “go go” years of early retirement required the same amount of income as the “slow go” or “no go” years of later retirement. Is there an optimum glide path for distributions instead of a straight upward slope including inflation? Should advisors suggest growth strategies for portfolios as retirees reach their mid-80s and have no legacy intent?

Strategically, does it make sense to grow the portfolio as large as possible, with no eye toward a safe withdrawal rate, or instead, have a floor of real income that cannot be outlived? Dr. Wade Pfau has invested hours of research and effort to show options and ways for advisors to evaluate an optimal divestiture strategy. With no bailout strategy or floor, the retiree may be heading off the proverbial cliff without an escape route. What is being termed the Fourth Generation of retirement planning has moved past this prehistoric thinking and is now more focused on a guaranteed income by utilizing a floor to prevent total devastation in the no-go years. Longevity planning is becoming more and more relevant as retirees routinely live 25 to 30 years past retirement.

New strategies include longevity insurance, building this floor with bond ladders and TIPS or annuities (using mortality credits). Other studies focus on lifestyle glide paths that allocate more income in the go-go years of retirement instead of using constantly inflating income assumptions with no practical consideration of age-based spending (not forgetting long-term-care risks). The amount allocated to the floor portion of the portfolio is based on the amount of wealth and income needed. Any surplus would be invested in the capital markets.

Factors that need analysis include risk tolerance, age and bequests considerations. In addition, the wise planner will build a sequence risk buffer into the portfolio to protect against the dreaded market crash in a capital market portfolio, guarding against a crash during the first six years of retirement (the most vulnerable period). Asset allocation for retirement takes on a whole different meaning from how a portfolio is structured—large and small cap, domestic and international, value and growth.


Retirement planning has entered a new phase of analytics that will benefit all practitioners and retirees. Learning the basics of retirement planning will help every advisor bring added value (called Gamma) to his or her clients. Be on the lookout for new thinking and strategies to help clients build sustainable income streams that will last their whole lives.

About the Author

Guy Baker, MBA, MSFS, CFP® is a financial advisor to business owners. He works to help owners find ways to reorganize their planning to achieve tax-efficient solutions to their succession, retirement and estate planning problems. Guy is a 34-year member of Top of the Table and recognized by Worth magazine as one of the top 250 financial advisors. For more information, you can contact him at guy@bmiconsulting.com or through www.bmiconsulting.com.