Is The 4% Withdrawal Rule Becoming Obsolete?
By Steven T. Merkel CFP®, CHFC®
October is National Retirement Security Month, which provides a great opportunity for you to reflect on your retirement goals and consider if your current financial plan aligns with those goals. One of the most important considerations you will make in regards to your retirement plan is determining a “safe” portfolio withdrawal rate. Your withdrawal rate reflects how much you can take from your portfolio yearly, and a “safe” rate aims to prevent you from depleting your savings early. You have worked hard for your savings, and you deserve to have the retirement of your dreams, but the wrong withdrawal rate may interfere with your vision for the future.
First, you and your financial advisor will need to assess your portfolio to determine when can you retire comfortably. Health and longevity, your personalized spending rate, life situations, types of investments, and risk tolerance are going to factor into how much you will need. One of the more popular savings calculation tools has been the 4% Rule.
The 4% Rule was created using historical data on stock and bond returns over 50 years, from 1926 to 1976 by financial advisor William Bengen. At the time of the study in 1994, it was generally considered that a 5% withdrawal rate was sufficient. He found that even during difficult market situations, no historical case existed in which a 4% annual withdrawal exhausted a retirement portfolio in less than 33 years. The rule also allows retirees to increase the rate to keep pace with inflation. That may include setting a flat annual increase that aligns with the Federal Reserve’s target inflation rate. However, the study has been updated, and Bengen has increased the safe withdrawal rate to 4.5% when holding a more diversified portfolio.
Bengen’s study was conducted nearly 30 years ago, and it may not capture the full picture of today’s retirement situations.
Assuming you have a diversified portfolio, which may include multiple sources of income such as:
- Social Security
- Real Estate Rental Income
We need to take into consideration the interest rate environment has changed quite a bit since the 1990s. In 1998, the 10-year bond yield was between 4.41% to 5.6%. In 1994 it was even higher. Therefore, back then, if you followed the 4% rule you would likely not run out of money.
Today, the 10-year bond yield is currently at ~0.7% and will likely remain there for some time. At this rate, $1 million will only generate $7,000 a year in risk-free, pre-tax income. Even with the maximum social security payment of $2,900 a month, that’s still only $41,800 a year in income. The 4% rule assumes that you will withdraw the same amount each year, adjusted for inflation, with stark rigidity. Any increase in spending completely throws it off the calculation.
The rule was created to be applied to a hypothetical portfolio invested in 50% stocks and 50% bonds. Your portfolio may not follow this exact allocation, and you may change your investments during your retirement. Your retirement is as unique as you, and your withdrawal rate may need to follow a different path. It may be more beneficial to adopt a personalized spending rate, based on your situation, investments, and risk tolerance, and then regularly update it.
It may also help to meet with your financial advisor regularly to review your budget and withdrawal plan to prevent any bumps in the road.
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