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Four or Less

Sanjib Saha

A RECENT ARTICLE from Morningstar suggested that the 4% rule for sustainable retirement withdrawals should be revised downward to 3.3%. This lower rate, the researchers argued, is safer given today’s rich stock market valuations and low bond yields.

The article also recommended being flexible with withdrawals, by taking larger amounts in good markets and smaller withdrawals during down periods. This strategy could provide more lifetime income than fixing a withdrawal amount in the first year and then automatically increasing that sum each year with inflation.

I like simple rules of thumb, but I only use them as ballpark estimates. The old 4% rule provides a quick, back-of-the-envelope sense of our retirement readiness. For instance, if we divide 100 by that 4%, we get 25. The upshot: If we have savings equal to 25 times our average annual spending, or something in that range, we may have enough to quit the workforce. For younger folks, I’d bump up the multiplier in recognition of longer life expectancies.

What if our retirement readiness passes this simple sniff-test? Now, it’s time for detailed calculations using individually tailored parameters. A ballpark estimate is not helpful at this stage.

My unease with the 4% rule—and I’m not alone—isn’t with the number’s accuracy. Rather, I’m uncomfortable with its widespread use as a one-size-fits-all withdrawal strategy. And, no, tweaking the recommended withdrawal rate up or down from a nice whole number to a decimal figure doesn’t necessarily make it more correct. Rather, it can simply create a stronger illusion of accuracy.

“Everything should be made as simple as possible, but not simpler,” as Albert Einstein may have said. Withdrawal strategies in retirement needn’t be too complicated. But a prescribed withdrawal rate—even with some adjustments here or there—strikes me as an over-simplified endeavor.

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Roboticus Aquarius
Roboticus Aquarius
8 months ago

4% is merely a simple rule of thumb, predicated on a 30 year investment period and a 50/50 portfolio of US Equities and US Bonds. Very few people actually stick to the 4% rule every year. Most tend to play it by ear, withdraw what they need, but also attempt to increase or decrease the amount depending on how their investments do that year.

The fact is, most retirees would have been able to get away with 5 or even 6% depending on whether they chose a lucky time to retire. A few could have survived at 7 or 8%. However, since we don’t know what future returns are on the date you retire, 4% gives you a measure of security for a 30 year retirement that a higher withdrawal rate won’t provide to you.

David Lamb
David Lamb
8 months ago

“If we have savings equal to 25 times our average annual spending, or something in that range, we may have enough to quit the workforce.”

How does annual “guaranteed” income from SS play into this?

Example: a 65 YO married couple with annual spending of $60K and collecting $40K from SS has a “spending deficit” of $20K. They have $1M in IRA/401K accounts, equivalent to 50 years worth of “spending deficit”. To my way of thinking, they could withdraw much more than that 4% rule-of-thumb if need be and still sleep well at night that they are not going to outlive their savings.

Roboticus Aquarius
Roboticus Aquarius
8 months ago
Reply to  David Lamb

Yeah, so the 4% rule is a measure of your portfolio investments/savings, not expenses. If you withdraw more than 4% of savings ($40K in your example of someone with a $1M portfolio), you are taking a risk that it won’t last 30 years (the term of the Trinity study the rule of thumb is based on.)

Now, when assessing the NEED to withdraw, that should be applied to unfunded expenses. In your example, that’s $60K total expenses less $40K SS income less pension or annuity which I’m assuming neither = $20K unfunded (2% of their $1M savings.)

Yes, they could withdraw more than the 2%, needed; they could withdraw 3 or 4% if they wanted to. They would have additional cash to put in their regular bank account or spend on luxuries, or replace a roof, for example… and their portfolio would likely still last 30 years.

Last edited 8 months ago by Roboticus Aquarius
parkslope
parkslope
8 months ago
Reply to  David Lamb

My understanding is that the 4% rule does not include SS or defined benefit pensions. The “rule” also assumes that the amount of money withdrawn is spent each year and is not reinvested. Thus a large withdrawal rate (e.g., 7%) would most likely exhaust the savings of your hypothetical couple in less than 25 years.

Ormode
Ormode
8 months ago

Just because you are required to take a withdrawal doesn’t mean you have to spend the money – you can always re-invest it in an after-tax account.

Sanjib Saha
Sanjib Saha
8 months ago
Reply to  Ormode

Thanks, Ormode. I think you are referring to the required minimum distribution rule from retirement accounts. As you say, it is really a “tax realization” rule rather than a spending rule, though the actuarial principle behind it can be useful for some to determine retirement withdrawal amounts too.

R Quinn
R Quinn
8 months ago

I read the same article. In fact, I wrote about it on my blog I was struck that the article starts by suggesting 3.3% as you say but ends up saying that 4% may be okay.

As you say one size does not fit all. On the other hand, average people trying to save and invest can benefit from an easy to understand target and it seems to me 4% is as good as any.

I think a prescribed rate of withdrawal is desirable for many, if not most people. Without it there is the risk of too much variation from year to year based on market performance or simply whims of spending. It acts as a sort of budget. If the withdrawal is not fully needed during a given period, save it for a rainy day.

Sanjib Saha
Sanjib Saha
8 months ago
Reply to  R Quinn

Thanks for sharing your blog, Richard. I completely agree that an easy-to-understand target is very helpful for people trying to save and invest. A 25-30 multiplier (or a higher number for younger folks) is great for that purpose. As for withdrawal budget in retirement, some folks use the single life expectancy table (which was originally meant for inherited IRA RMDs in the past, and can be found in appendix B of IRS pub-590B) as an “upper-limit” guideline.

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