The Safe Withdrawal Rate: A View from 60,000 Feet
Retirement is often seen as a time to relax and unwind after years of hard work, but recent events have made it more difficult to predict what the future holds. With the collapse of two major banks, lingering pandemic concerns, persistent inflation, and market volatility, many people are worried about their retirement nest egg and how much they can withdraw safely without running out of money.
To address these concerns, the traditional 4% rule has been used as a guideline, but recent events have raised questions about its sustainability. In this article, we’ll explore everything you need to know about the 4% rule and whether it’s still relevant today.
What Is the 4% Rule?
The 4% rule is a theory about how much money you can safely withdraw from your retirement accounts each year without running out of money. It became widely publicized after Bill Bengen’s research in 1994, which showed that withdrawing up to 4% of retirement assets, and then adjusting annually for inflation, could sustain the typical 30-year retirement going all the way back to 1926.
On the surface, it may seem like withdrawing 4% is definitely the way to go. After all, the data goes back nearly 100 years! But the biggest mistake retirees make is not understanding what assumptions go into the research and why it might not apply to everyone.
It may not be flexible enough.
The 4% rule is a rigid guideline that assumes you will increase your spending each year by the rate of inflation, regardless of how your portfolio performs. This may not be flexible enough for some retirees who may experience fluctuations in their expenses from year to year, and they may need to adjust their withdrawal rate accordingly.
It assumes a 50/50 portfolio.
The 4% rule was developed based on a hypothetical portfolio of 50% stocks and 50% bonds. If your asset allocation is different, or if you have a more aggressive or conservative investment strategy, the 4% rule may not be the best guideline for you. Generally, with a higher allocation toward stocks, there is a greater degree of uncertainty introduced to retirees’ portfolios which could affect the withdrawal rate.
It analyzes historical returns.
As every financial professional will tell you, “Past performance doesn’t predict future returns.” Yet the research backing the 4% rule is based on historical market performance. Research by Charles Schwab Investment Advisory, Inc. suggests that stock market returns over the next 10 years will be below the historical average. Basing your withdrawal rate on historical returns could result in withdrawing too much too quickly.
It assumes a 30-year retirement.
If you retire at age 65, a 30-year retirement would last through age 95. Depending on your specific situation, that scenario may be unlikely. Maybe you have a family health history that makes living to 95 unlikely, or perhaps you retired early and expect to have a 40-year retirement instead. Whatever the case may be, it’s important to understand how your retirement reality stacks up against the hypothetical retirement modeled in the research. A longer retirement time frame means you will need to withdraw less than 4%, while a shorter retirement horizon would allow you to withdraw more.
It doesn’t include taxes or investment fees.
Arguably the most important assumption of the entire study is that it doesn’t take taxes or investment fees into account when determining the withdrawal rate. Rather, Bengen assumed that all taxes and fees would be paid from your withdrawal. This has real-life implications in that what you withdraw might not actually cover your expenses on an after-tax basis. It also doesn’t account for the fact that investment management fees will reduce returns over the life of your portfolio.
Is it Outdated?
A quick Google search of the 4% rule will turn up article after article debating whether or not it is broken and outdated. Research from Morningstar in 2021 suggested that the 4% rule was effectively dead due to economic factors like low bond yields, high stock valuations, and high inflation. Since that research came out, interest rates have risen substantially and there have been several market corrections. Inflation is still high, but coming down from its peak in 2022. The most recent research from Morningstar now suggests that the 4% rule is back and retirees can safely withdraw 3.8% in the first year of retirement and adjust for inflation annually.
Partner With a Professional
It seems that the question about the 4% rule does not have an exact answer. As with most things in financial planning, the answer is dependent on each person’s unique retirement profile. Regardless of the fluctuations in the research over the years, the 4% rule is a good starting point for a more in-depth assessment of your particular retirement needs.
If you’re unsure about how to proceed with your retirement planning or have any questions, get in touch! We can help you create a personalized retirement plan that takes into account your goals, risk tolerance, and unique financial situation. Don’t hesitate to reach out for professional guidance and start taking control of your retirement today. Book a free introductory meeting online!
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Preston Rosamond is a financial advisor and the founder of The Rosamond Financial Group Wealth Management, LLC with over two decades of industry experience. He provides comprehensive wealth management and financial services to successful business owners, corporate executives, and affluent retirees who enjoy simplicity and seek a professional to help them pursue their goals. Preston personally serves his clients with an individual touch, a sincere heart, and his servant’s attitude is evident from the moment you meet him. Learn more about Preston or start the conversation about your finances with him by emailing email@example.com or schedule a call on his online calendar.