The 4% Rule for Retirement Withdrawals -- A Few Observations

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This article was posted September 1, 2016.

The 4% Rule is the well-worn retirement planning advice that one can take a first year withdrawal of 4% from a reasonably well-diversified portfolio (e.g., $40,000 from a $1 million portfolio) and then adjust that annual withdrawal for inflation in subsequent years with considerable safety. The concept is buttressed by several academic studies using historical stock market returns.

The 4% rule will likely leave you with a lot more money than you think

Whenever the stock market reaches new highs, it's common for so-called retirement experts to warn that we're in new territory and the 4% rule no longer applies. Given that history, it was surprising to see this observation from financial planner Michael Kitces:

The 4% retirement rule has quintupled wealth more often than depleting principal after 30 years!

Note that "depleting principal" doesn't mean that your retirement nestegg goes to zero. Surviving 30 years without "depleting principal" on a $1 million portfolio means that you end that 30 year period with the same $1 million you started with, even after the 30 years' worth of annual withdrawals.

Pretty amazing!

Higher income folks are likely to live a lot longer than they think

Looks like income may be a bigger factor in most folks longevity than genes. A study on longevity by the Treasury Department had some startling news for retirees. The Washington Post summarized the findings in a September 2015 article. (See, "The stunning — and expanding — gap in life expectancy between the rich and the poor").

Men in the top 20% of the income distribution live 5.4 years longer than those with a median income (88.8 vs. 83.4 years) For women, the figure is 12.2 years longer for the Top 20% (91.9 vs. 79.7 years). For 2015, the Top 20% of the US income pyramid starts at a household income of about $115,000 per year. The median US household income is $54,000 per year. (In terms of net worth, you enter the Top 20% with a net worth of $429,000. The median net worth in the US is $81,000.)

People spend less as they age

While the "4% rule" assumes your spending will rise in lockstep with inflation, an examination of retiree's actual spending shows it declines as they age -- even including health care costs. This phenomenon makes the "4% rule" even more conservative.

Delaying Social Security until age 70 is the least expensive way to improve your retirement portfolio survivability.

If you believe that you're likely to live beyond the age of 82 or so, it makes financial sense to delay the start of your Social Security benefits to age 70 if you can afford to do so. Delaying Social Security from age 62 to age 70 increases your monthly benefit by about 75%. A larger, inflation-adjusted Social Security benefit allows for smaller retirement portfolio withdrawals. Thus, improving the chance you won't outlive your money if you see the longer lifespan forcast for high income earners.

Resources for more information

The Growing Gap in Life Expectancy by Income: Implications for Federal Programs and Policy Responses (2015) -- The National Academies of Sciences, Engineering, and Medicine

Bengen, William P, “Determining Withdrawal Rates Using Historical Data”, Journal of Financial Planning, October 1994, pp 171-180, Volume 7, Number 4.

You’ll Spend Less As You Age -- Time Magazine, Feb 26, 2014

Issues in Assessing Trade Execution Costs, Journal of Financial Markets Bessembinder, H.

Evaluation of the biases in execution cost estimation using trade and quote data Peterson, M., and Sirri, E.