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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.
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.
“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.
That’s a great point about social security, which the 4% rule ignores. Social security is “like bonds” (actually more like a lifetime annuity), meaning you can reduce your stock allocation accordingly.
The book “Lifecycle Investing” addresses this in detail with tons of simulations, and I remember the takeaway being that “50/50 stocks and bonds” should be more like “80/20 stocks and bonds” for a conservative investor when you account for social security.
Yeah,