Is The 4% Rule Dead?

cash withdrawalMany financial planning practitioners employ a simple rule of thumb that says you can generally count on withdrawing 4% of the value of your portfolio each year in retirement without the risk of it depleting prematurely.

For example, if at age 65 your total portfolio (including the value of your 401k and IRAs) totals $500,000, you could withdraw about $20,000 each year and probably not run out of money even if you live to age 95.

Note the word “probably.” There are always things that can go wrong.

Kelly Greene of the Wall Street Journal wrote a good update on the debate over the 4% rule in March, and noted some of those variables that could make for a nasty surprise.

For example, higher than expected inflation, bad performance by stocks or bonds, and investment declines in the early years of your retirement can all crash the party.

But here’s my view:  As a rule of thumb, it’s not bad.

What’s Good About The 4% Rule

The biggest advantage of the 4% rule is that people can understand it. It’s easy to communicate to clients, and provides a handy mental guideline they can use every day to monitor their spending.

Keep in mind that 40% of pre-retirees surveyed by MetLife in their annual retirement study believe they can withdraw from 7% to 15% of their portfolio each year and not run out of money. So whether the 4% estimate is a little too high, a little too low, or just right, at least it has the virtue of positioning clients in the right ballpark.

Plus, you can always tweak it to suit your needs. For example, the original version of the rule called for calculating the 4% withdrawal amount at the beginning of retirement, based on the original portfolio market value, and increasing it for inflation each year.

We don’t handle it that way in our office.  We use a more dynamic process where we recalculate withdrawals each year based on current market values. That encourages retirees to reduce withdrawals during market declines. We also take a different snapshot (kind of a “second opinion”) by calculating target withdrawal amounts based on IRS life expectancy (RMD) tables, allowing for bigger withdrawals at older ages.

When we talk about the 4% rule, clients understand why even retirees need a healthy dose of stocks in their portfolio.  The 4% rule is predicated on a portfolio with 60% stocks and 40% bonds.  If you haven’t allocated that much to stocks, or close to it, your portfolio won’t grow as fast and you may run out of money sooner.

A Little Perspective

It’s great that the deep thinkers in our profession continue to research this topic. Certified Financial Planner (CFP) practitioners, like us, want and need to know as much as we can about sustainable withdrawal rates so we can keep clients on the right path.

But, in fact, we don’t lose sleep so much over the clients withdrawing 4.5%, or 3.5%, or even 5%, as we do over the clients withdrawing 10% and 12%.

So for all you non-CFP professionals out there, don’t sweat it. If you’ve gotten the message that withdrawals in the 3% to 5% range are OK, and that’s indeed what you are taking out, pat yourself on the back, and call it a good day. After all, you should have at least 11,000 more of those days left until you out run out of money!






About Mari Adam

Mari Adam, Certified Financial Planner™ has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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