Revisiting the 4% Withdrawal Rule for Allstate Employees

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After leaving Allstate, it can be difficult to save for retirement, and it can be equally challenging to use those savings prudently. How much can you withdraw annually from your savings? This is an important issue that many of our Allstate clients frequently ask, and with good reason: if you withdraw too much, you risk running out of money, but if you withdraw too little, you may lose out on a comfortable Allstate retirement.

The '4% rule' has been the most prevalent guideline for over 25 years. This rule suggests that a withdrawal equal to 4% of the portfolio's initial value, with annual adjustments for inflation, is sustainable over a 30-year retirement period. This guideline can assist Allstate employees in establishing a savings objective and providing a realistic picture of the annual income their savings could generate. For example, a $1 million portfolio could generate $40,000 in the first year, followed by inflation-adjusted withdrawals.

Over the years, the 4% rule has generated substantial debate, with some experts contending that 4% is too low and others arguing that it is too high. Due to the allegations, we believe it is necessary to analyze both the original and most recent research regarding the 4% rule with our Allstate customers. The rule's creator, financial expert William Bengen, believes it has been misconstrued and provides new insights based on recent research. Determine whether he is right. 

Original research

Bengen published his findings for the first time in 1994, after analyzing data for retirements from 1926 to 1976 — a total of 50 years of data. He considered a hypothetical conservative portfolio consisting of fifty percent large-cap equities and fifty percent intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. In the worst-case scenario, retirement in October 1968, a 4% inflation-adjusted withdrawal rate was the greatest sustainable rate. This marked the onset of a prolonged bear market and high inflation. All other retirement years featured higher sustainable rates, with some exceeding 10%.[1]

Obviously, no one can predict the future, which is why Bengen proposed a sustainable rate based on the worst-case scenario. Based on a more diversified portfolio of 30% large-cap equities, 20% small-cap stocks, and 50% intermediate-term Treasuries, he later increased it to 4.5%.[2]

New research

Now that we comprehend Bengen's original research, we'd like to examine a more recent analysis conducted with Allstate clients. Bengen published new research in October 2020 that attempts to project a sustainable withdrawal rate based on the valuation of the stock market and inflation (the annual change in the Consumer Price Index) at the time of retirement. Theoretically, when the market is expensive, it has less potential for growth, and it may be more difficult to sustain increased withdrawals over time. Lower inflation, on the other hand, results in lower inflation-adjusted withdrawals, allowing for a higher initial rate. A first-year withdrawal of $40,000 becomes $84,000 after 20 years with a 4% annual inflation increase, but only $58,000 with a 2% increase.

Bengen used Shiller CAPE, the cyclically adjusted price-earnings ratio for the S&P 500 index devised by Nobel laureate Robert Shiller, to measure market valuation. The price-earnings (P/E) ratio of a stock is the share price divided by the stock's 12-month earnings per share. For instance, if the price per share of a stock is $100 and its earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE is calculated by dividing the total share price of S&P 500 equities by their 10-year average inflation-adjusted earnings.

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5% Rule?

Bengen utilized historical data once more, this time for over sixty years of retirement. Bengen discovered a correlation between market valuation and inflation at the time of retirement and the utmost sustainable withdrawal rate by analyzing retirement dates from 1926 to 1990. Historically, rates ranged from as low as 4.5 percent to as high as 13 percent, but the scenarios that supported high rates were rare, involving extremely low market valuations and/or deflation rather than inflation.[3]

Since the Great Recession, the United States has experienced low inflation and high market valuations for the majority of the last 25 years.[4-5] Bengen found that a 5% initial withdrawal rate was sustainable for 30 years in a high-valuation, low-inflation scenario at the time of retirement.[6] While this is not a substantial deviation from the 4% rule, it does suggest that retirees could make larger initial withdrawals, particularly in an environment with low inflation. However, when inflation is significant, withdrawals should decrease. 

A caveat is that the market's current valuation is extremely high: At the end of 2020, the S&P 500 index had a CAPE of 34.19, a level only attained (and surpassed) during the late-1990s dot-com boom and higher than any of Bengen's research scenarios.[7] His range for a 5% withdrawal rate is a CAPE of at least 23 and an inflation rate between 0% and 2.5%.[8] (Inflation in November 2020 was 1.2%.)[9] Bengen's research suggests that a 6% withdrawal rate may be sustainable if inflation is 5% or less and market valuation falls to near the historical mean of 16.77. Alternatively, if valuation remains high and inflation exceeds 2.5%, the utmost sustainable rate could reach 4.5%.[10]

Allstate employees must remember that these projections are based on historical scenarios and a notional portfolio, and there is no assurance that their portfolio will perform similarly. Allstate employees must also keep in mind that these calculations are based on annual withdrawals adjusted for inflation, and you may choose not to increase withdrawals in certain years or use other criteria, such as market performance, to make adjustments.

Although there is no guarantee that working with a financial professional will improve investment performance, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, such as your withdrawal strategy.

We would like to remind our Allstate clients that all investments are subject to market volatility, risk, and principal loss. Investments may sell for more or less than their initial cost upon sale. The timely payment of principal and interest on U.S. Treasury securities is guaranteed by the federal government. Treasury securities' principal value fluctuates with market conditions. They may be worth more or less than the amount paid if not held to maturity. Allocation of assets and diversification are techniques used to manage investment risk; they do not guarantee a profit or guard against investment loss. Rebalancing requires the sale of some investments in order to purchase others; the sale of investments in a taxable account may result in a tax liability.

The S&P 500 index is an unmanaged collection of stocks that is representative of the U.S. stock market as a whole. The performance of an unmanaged index is not indicative of any particular investment's performance. Individuals cannot invest in an index directly. Past performance is not indicative of future performance. The actual outcomes will differ.

Conclusion

Imagine you are on a road trip, driving through unfamiliar terrain. You come across a fork in the road, with one path leading towards a beautiful and scenic destination, while the other path looks rocky and uncertain. The decision you make at this juncture could have a significant impact on your journey and your ultimate destination. Similarly, retirement is like a fork in the road of life. One path leads to a comfortable and enjoyable retirement, while the other path could lead to financial difficulties and hardship. This article provides guidance on how to navigate this fork in the road, with tips on how to save and invest wisely, how to plan for unexpected events, and how to ensure a comfortable retirement. Whether you are a Allstate worker looking to retire or an already existing retiree, the information in this article is pertinent to you and will help you make the best decision for your retirement journey.

1-2) Forbes Advisor, October 12, 2020
3-4, 6, 8, 10) Financial Advisor, October 2020
5, 9) U.S. Bureau of Labor Statistics, 2020
7) multpl.com, December 31, 2020