There is no shortage of studies examining "safe" withdrawal rates from the portfolios of retirees. I doubt a week goes by that a major personal finance publication fails to put out a piece referencing or critiquing the studies. Like many financial planners, I have found the studies helpful in framing some of the issues facing retirees. Neither the studies, nor the press coverage of the findings, however, adequately address the nuances faced in the real world. In the coming months, I hope to bring more attention to several of the issues that arise in managing a retiree's finances that can be problematic when one converts study findings into rules of thumb.

This is not a knock on the studies by any means. Most of them are done well. I recommend every financial planner study the works of Bengen, Kitces and Guyton. I find them each particularly interesting and useful. That's said, all examinations of portfolio sustainability have limitations. It is one thing to model a particular scenario, but the real world often presents several nuances over the course of a client's retirement, sometimes simultaneously, and often in a very different sequence from family to family.

Bill Bengen, CFP, is the man most responsible for the "4% rule" though he has not used that term to describe his findings. His "Determining Withdrawal Rates Using Historical Data," from the October 1994 issue of the Journal of Financial Planning, has had such influence that it was named one of the best in the publication's first 25 years.

Bengen determined that if a person withdrew 4% ($40,000 from a $1,000,000) from a simple diversified portfolio with a fairly conventional asset allocation, they could increase that amount by the inflation rate each year and would likely still have some funds after 30 years. In the ensuing years, a slew of additional papers have examined the issue. Bengen himself expanded on the work in his book, Conserving Client Portfolios During Retirement. In it, he altered several variables, such as the sophistication of the asset allocation, one variable at a time building upon the prior adaptations in a manner he described as building a layer cake. The result of these layers is a safe rate that could be closer to 5%.

Michael Kitces, CFP, publisher of The Kitces Report, examined the issue from a different angle, examining the effect market valuations have on the withdrawal rate problem. In its simplest form, his work found that when market valuations are low, future returns tend to be higher and therefore can support a higher withdrawal rate. When valuations are high, lower withdrawal rates are indicated.
Jon Guyton, CFP, looked at the issue in a different way than most. He examined how some of the actual decisions people faced while withdrawing might affect the determination of a safe withdrawal rate. Guyton defined "safe" as "the maximum rate that can achieve these conditions:

1. Never requires a reduction in withdrawals from any previous year

2. Allows for systematic increases in withdrawals to offset (some) inflation

3. Maintains the portfolio's ability to satisfy the first two conditions for at least 40 years

He then tested the effect of a series of decision rules against the period from 1973-2003 highlighted by two severe bear markets and a period of prolonged, abnormally high inflation. He applied rules to determine how much should be withdrawn each year, from where exactly in the multi-asset class portfolio does the money come, and how should the portfolio and withdrawals be altered in years in which there are gains versus changes employed when there are investment losses.

His efforts resulted in winning the Journal of Financial Planning's Call for Papers competition in the practitioner's division for 2004 with, "Decision Rules and Portfolio Management for Retirees: Is the 'Safe' Initial Withdrawal Rate Too Safe?" Guyton's conclusion was a safe withdrawal rate seems to be between 5.8 and 6.2% if his "decision rules" were employed.

I have greatly oversimplified the work of all three of these gentlemen. These are must-reads for anyone advising a retiree, and I have no arguments with any of them. But there is more to it than a safe withdrawal rate when managing retirement assets. These and other studies inevitably create a model to incorporate economic and market factors. Reality clashes with the theory behind these works because of differences on a very personal level rather than the macro level on which these works operate.

Perhaps the simplest example is to imagine two 65 year olds with identical assets, income from pensions and Social Security, and expenses. Sustainability theory implies both have equal chances of not outliving their assets, but that may be far from true.

We have had retired clients get cancer, arthritis, Alzheimer's, or any of a host of other ailments--all of which can cost money beyond what even good health and long-term-care insurance will cover. It may be a morbid thought, but one could also argue that the sick have a greater probability of not outliving their assets because their time frame is shorter. Clients don't generally view that as a positive even if the mathematics might. Reality versus theory.

More than a few 65 year olds have parents who are still alive. Many of these parents need some help financially as well as physically and emotionally. Some live far away from our clients, adding costs not planned for on top of other support.

Clients have divorced and married new people. Others remarried their ex-spouses. Some decide to forgo the "I do's" and cohabitate with their new companions. All such choices have financial implications.

Children of clients get arrested, go to rehab, or marry people our clients just do not like or trust. Our clients can incur all sorts of "off-budget" expenditures to help these kids. They buy them cars and houses, pay for therapy, hire lawyers, and payoff credit cards. Many have an even softer heart for their grandchildren. Helping with a college fund is probably the most popular desire we hear, but some grandparents even raise their grandchildren because their children can't or won't.

Life happens. We simply cannot model every contingency and cannot hedge every risk. However, one thing we can do is be aware of what some of the sudden changes we face are likely to do to a given family's retirement.

Our two 65 year olds will face different life events, but even if their lives unfolded in an identical manner their prospects for sustainability may differ greatly simply because the types of assets they have are different even if the values are identical today. Reality clashes with theory once again. In my next column, I will start to examine some of these financial differences.

Dan Moisand, CFP, has been featured as one of the America's top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager and Worth magazines. He practices in Melbourne, Fla. You can reach him at 321-253-5400 or dan@moisandfitzgerald.com