The 4% rule during retirement

Retirement Calendar

The cover story in the October 2014 issue of the Journal of Financial Planning was on the “4% Rule.” This rule of thumb for a safe retirement withdrawal rate was first suggested by financial planner Bill Bengen in his article “Determining Withdrawal Rates Using Historical Data,” published 20 years ago in October, 1994. Bengen, who received his degree from MIT in aeronautics and astronautics prior to becoming a CFP®, studied rolling 30-year periods of market data to answer the question: “What is a sustainable and safe withdrawal rate in retirement?” His research led him to this conclusion:  Retirees could withdraw 4% from their portfolio in the first year of retirement, then in each subsequent year adjust that amount by the inflation rate, and continue this successfully over a lifetime.

For most people as they approach retirement or live in retirement, Bengen’s question is the exact right question to ask. We want to know what we can plan on spending in retirement without jeopardizing the future.  Now that it is 20 years later, does Bengen’s 4% rule still hold?

There are articles in the financial planning industry that say the 4% rule is dead.  Some disagree.  I would say that the rule is a great place to start our thinking, but there are limitations in the original construct that are being accounted for in the new research today.  For example, the 4% rule assumed specifically a 30 year retirement.  For those in their 50s and 60s, does it make sense to plan for 30 years? Or 40 years?  CFP® Wade Pfau asks the question, “Does it really make sense to lower one’s spending now, because you are specifically planning to spend just as much when you are 105 as when you are 65, despite the less than 1% chance of living to 105?”* Or might we want to have a dynamic approach that accounts for increasing longevity, as the IRA Required Minimum Distribution tables do?

Another limitation in the rule is that it results in a constant, inflation-adjusted dollar amount for withdrawal. If the portfolio experiences a bad year or two in market returns, the amount withdrawn from a diminished portfolio may well be a higher percentage of the portfolio than expected.  It may not make sense in the long run to plan for a constant withdrawal amount from a portfolio that is dynamic in results. Might we want to utilize a more flexible withdrawal percentage in our planning to further insulate the portfolio?

Bill Bengen’s question is a great question, and his 4% rule is a great starting point to a thoughtful, educated conversation on the topic.  Additional research is being conducted and published, and as it sheds light on the topic, we will continue to bring it to your attention.

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