Rules of thumb and retirement accounts

We examine the welfare costs of using common rules of thumb for saving, investing, 401k contributions, and withdrawals in a realistic environment with taxes, Social Security, 401k plan details, and uncertainty in income, lifespan, and returns. We assess common heuristics such as allocating 100 minus age to stocks, contributing 6–10% of income to a 401k, and withdrawing only the required minimum distribution (RMD) in retirement. Target-date rules lead to moderate welfare losses, with one-time compensating variations ranging from $59–$2514 for 401k allocation and $66–$873 for other savings. Contribution rules cause smaller losses ($22–$772), reflecting the importance of the 401k matching incentives. Withdrawing only the RMD leads to substantial welfare losses, ranging between $1321–$9919 from the perspective of a 66-year-old. But a hybrid rule—taking the maximum of a fixed percentage and the RMD—generates welfare losses about half as large as those associated with the RMD rule. We also compare these rules to more clearly suboptimal behaviors, such as avoiding the stock market, delaying saving, or contributing below the matching threshold. In these cases, rules of thumb look far more attractive, often avoiding substantial welfare losses. Overall, we find mixed support for the effectiveness of rules of thumb. While the welfare losses associated with such rules are modest, there may be substantial benefits to more detailed financial planning.