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Revisiting the 4% Withdrawal Rule for Target Employees

After leaving Target, 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 Target 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 Target 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 Target 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 Target 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 Target 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]

Target 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. Target 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 Target 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 Target 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

What are the key benefits provided by Target Corporation's Personal Pension Account and Traditional Plan for employees approaching retirement, and how do these plans ensure financial security during retirement years? Understanding the synergy between these two plans is essential for retirees, as they work together alongside Social Security and personal savings to replace a portion of an employee's paycheck after retirement.

Key Benefits of the Personal Pension Account and Traditional Plan: Target Corporation's pension plan includes two components: the Personal Pension Account and the Traditional Plan. These plans work in tandem to replace a portion of an employee's paycheck during retirement. The Personal Pension Account provides pay credits and interest that accumulate over time, while the Traditional Plan uses a final average pay formula. Together with Social Security and personal savings, these plans help ensure financial security in retirement(Target Corporation_Dece…).

How can employees elect different payment options, such as the Single Life Annuity or the Joint and Survivor Annuities, within Target Corporation's pension plans? It is crucial for employees to grasp not only the financial implications of these choices but also the necessary spousal consent required when designating a joint annuitant, particularly if the chosen joint annuitant is not the employee's spouse.

Payment Options and Spousal Consent: Employees can elect different payment options, including the Single Life Annuity, which provides the highest monthly benefit and ceases at the retiree’s death, or the Joint and Survivor Annuity, which continues payments to a surviving spouse. To elect a non-spouse as a joint annuitant, spousal consent is required, and this must be notarized to ensure compliance with plan rules(Target Corporation_Dece…).

In what circumstances might benefits not be paid under the Traditional Plan, and what steps can employees take to ensure they remain eligible for their pension benefits upon termination of employment? Target Corporation's policy outlines several scenarios where benefits could be denied, making it necessary for employees to be proactive in understanding their rights and responsibilities concerning plan participation.

Circumstances for Denial of Benefits under the Traditional Plan: Benefits under the Traditional Plan may not be paid if an employee leaves before becoming vested (less than three years of service). Employees should ensure they meet the vesting requirements and maintain eligibility by avoiding termination before they reach the minimum service period(Target Corporation_Dece…).

What procedures should employees follow to report changes in marital status, address, or beneficiaries to ensure compliance with the requirements of Target Corporation's pension plan? Employees must understand the importance of timely reporting these changes to avoid potential issues with their retirement benefits and ensure that their pension plan information remains up-to-date.

Reporting Changes in Marital Status or Beneficiaries: Employees must promptly report changes in marital status, address, or beneficiaries to Target's Benefits Center to ensure their pension records remain up-to-date. Failing to do so can lead to delays or issues in processing pension benefits(Target Corporation_Dece…).

How does Target Corporation determine the final average pay used to calculate retirement benefits under its pension plans, and what factors may affect this calculation? Employees nearing retirement should be fully informed about how their compensation is considered in determining their pension benefits, including aspects such as bonuses and overtime that may influence their final average pay calculation.

Final Average Pay Calculation: Target Corporation calculates final average pay based on the five highest years of earnings out of the last 10 years of service. This includes regular pay, overtime, bonuses, and commissions but excludes items like workers' compensation or long-term disability payments(Target Corporation_Dece…).

How can employees begin the process of rolling over their Target 401(k) accounts into the Pension Plan, and what advantages does this Pension Purchase Program offer? Understanding this rollover option is vital for maximizing retirement benefits, as it can provide employees with a stable income stream while avoiding unnecessary fees typically associated with purchasing annuities outside the plan.

Rolling Over 401(k) into the Pension Plan: Employees can roll over their 401(k) accounts into the Pension Plan using the Pension Purchase Program. This option offers several advantages, including avoiding fees associated with purchasing annuities outside the plan and receiving a stable income stream during retirement(Target Corporation_Dece…).

What are the implications of a participant's age and joint annuitant's age on the payment amounts under the various Joint and Survivor Annuity options at Target Corporation? Employees should be aware of how age differences can impact their pension payouts, as the specific percentages payable under these options may vary based on the ages of both the participant and their designated joint annuitant.

Effect of Participant and Joint Annuitant’s Age on Payments: The Joint and Survivor Annuity options are influenced by the ages of both the participant and the joint annuitant. The younger the joint annuitant, the lower the monthly payout due to actuarial adjustments. Employees should consider these factors when selecting an annuity option(Target Corporation_Dece…).

How are retirement benefits managed during potential plan terminations or amendments at Target Corporation, and what protections are in place for employees in these scenarios? Employees should be well-informed regarding their rights in the event of changes to the pension plan, including how benefits would be distributed and under what circumstances they may remain fully vested.

Plan Terminations or Amendments: In case of plan terminations or amendments, vested benefits are protected, and employees will receive their earned pension. If the plan is amended or terminated, Target ensures that vested benefits are distributed according to the plan's terms(Target Corporation_Dece…).

For employees retiring or leaving Target Corporation, what options are available with respect to unused vacation time and how might this be factored into pension calculations? Understanding how accrued time off translates into benefits could have a significant impact on an employee's financial positioning upon retirement.

Unused Vacation Time and Pension Calculations: Unused vacation time does not directly affect pension benefits but can be included in eligible earnings calculations that determine final average pay. Employees nearing retirement should consult with Target’s Benefits Center to understand how unused time may impact their overall benefits(Target Corporation_Dece…).

How can employees contact Target Corporation for assistance with their retirement benefits to address any questions or concerns they may have about their pension plans? Accessing the right resources and support is essential for employees to navigate their retirement benefits effectively. They can reach out to the Target Benefits Center at 800-828-5850 for more specific inquiries related to their personal circumstances. These questions aim to enhance employees' understanding of their retirement benefits, ensuring they are well-prepared for their transition into retirement.

Contacting Target for Pension Assistance: Employees can contact the Target Benefits Center at 800-828-5850 for assistance with their retirement and pension plans. This center provides support with any questions related to pension options, payments, and administrative requirements(Target Corporation_Dece…).

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For more information you can reach the plan administrator for Target at 10 South Dearborn Street 48th Floor Chicago, IL 60603; or by calling them at 1-800-440-0680.