You saved for decades. The hard part comes next, deciding how much to take out each year without running dry. Capital Group, the biggest manager of active target-date funds, put its answer in writing on Wednesday, Oct. 21. Target-date funds shift from stocks toward bonds as you age. Its own funds hold nearly half a trillion dollars for 11 million 401(k) savers.
The first rule is a fixed paycheck. Take 4% to 4.5% of your balance the year you retire. Then take that same dollar amount every year, raised for inflation. It's the old “4% rule” with a little room on top. Capital Group says it fits people with big fixed bills and little income outside the 401(k). The catch is a run of unusually bad markets. That can drain the account late in life.
The second rule is a flexible paycheck. Take 5% to 5.5% of whatever the balance is at the end of each year. In a down year you take less, so the account is much less likely to run dry. The trade is a paycheck that changes size. That suits people who can cut spending when they need to.
What the research says
Capital Group ran both rules through many market scenarios. In those tests, the fixed 4% draw left at least a tenth of the starting balance at age 95 in 84% of cases. Under the flexible rule, the chance of running out was minimal. The middle outcome kept about 74% of the original balance. That counts required minimum distributions, the yearly withdrawals tax law forces later in life. Without them it kept more than 100%. Read the 84% carefully. It's the chance of keeping a tenth of the money, and a tenth is a thin cushion at 95.
Rivals Vanguard, BlackRock (BLK) and Fidelity have announced target-date funds with a built-in option to buy an annuity, a paycheck for life. Capital Group hasn't. Michelle Black runs its target-date funds. She told the Journal's Jack Pitcher that “buying an annuity is a decision you can't undo.” A withdrawal rule, she says, can change any time. Employers want retirees to stay in their plans, the paper notes, because bigger plans can bargain for lower fees.
Our read
This is Retirement, M10, and the choice is older than any fund. It's a fixed paycheck or a flexible one. The fixed rule gives you a number you can plan a life around. The flexible rule protects the account and asks you to bend. Many retirees land in between. They cover the bills that never move with Social Security, a pension or a fixed draw. Think of the mortgage, insurance and the Medicare premium. A flexible draw pays for the rest, like travel, gifts or a new roof. Teachers and public workers can use the same math in a 403(b) or a 457 plan. Many of those plans offer target-date funds too.
So here's the check. Open your 401(k) or 403(b) app this week and find the balance. Take 4% of it, then 5%. That's the first-year gap between a fixed paycheck and a flexible one, in your own dollars. Add Social Security and any pension to the 4% figure. If that total doesn't cover your fixed bills, you need another income source before any withdrawal rule can do its job. If you'd like us to run both rules against your real bills, bring the statement and we'll do it together.