What’s My Number?

Answer: Once again, the answer is “it depends” on your personal situation. The four percent rule is popular and widely used. Assuming a life expectancy of 30+ yearsto enjoy your retirement years, the “rule” presumes a 4% withdrawal amount of the balance of retirement savings in the first year of retirement. According to a widely cited research paper titled “Determining Withdrawal Rates Using Historic Data,” written by William Bengen, and published in the Journal of Financial Planning in 1994, the rule is based on a 50/50 mix of stocks and bonds.  

Still Relevant? 

Consumer and industry publications recently published articles stating that the 4% rule is dead and that a lower 3% distribution rate is now appropriate. In 2021, Morningstar published a research paper calling the 4% rule no longer feasible andsuggested a 3.3% withdrawal rate. Fast forward 12 months later to mid-2022, and the same researchers updated their study proposing a sustainable rate of 3.8%. It’s evident that ongoing monitoring and the willingness to adjust in response to changes is encouraged.  

According to Investopedia, changes in asset values of retiree’s investments will influence the failure or success of any withdrawal strategy. Life expectancy is another determining factor. Calculating the probability of success became more important because life expectancies increased, and people may want to retire earlier. Finance professors Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz, with Trinity University,found that withdrawing more than 6% per year from a retirement portfolio led to significant failure rates. Individual tax rates (federal and state) will vary and also impact these calculations.  

Individuals who withdrew 4% of their portfolio each year (adjusted annually for inflation) over 30 years were successful 96% of the time, according to Bengen’s research. Success in this situation means that the ending portfolio value is greater than the value at the first year of retirement.  

For example, a couple with a $1,000,000 portfolio who used the 4% rule over 30 years had a 96% chance of passing away with a portfolio value greater than $1,000,000. An individual had a 50% chance of passing away with a portfolio value of 1.6 times the value of their portfolio in the first year of retirement. Another way to view this is that a couple with a $1,000,000 portfolio who adhered to the 4% rule over 30 years (adjusted annually by inflation) had a 50% chance of passing away with a portfolio value of over $1,600,000. 

The 4% rule was developed by looking at the worst possible time for someone to retire (October 1968 which was the perfect storm for a terrible stock market and high inflation). As more articles and studies question whether the 4% rule is still relevant, it is important to consider current stock valuations, interest rates, and inflation. William Bengen was motivated to study and address these concerns and now believes the appropriate withdrawal rate is actually between 4.5-4.7%, which is nearly 15% higher than his original rule of thumb.  

Takeaway 

The 4% rule is a great starting point when designing a retirement income strategy. Factors such as age, health status, life expectancy, income sources, changes to spending goals, and more, all play vital roles in the amounts individualsor familiesmay withdraw from their retirement portfolio now and in the future.  

Typically, there are three stages in retirement; the “go-go” years, the “go-slow” years, and the “oh no!” years. Each phase requires different funding levels. Health care costs tend to be greater in later years, while travel and more immediate needs are front-end loaded in the “go-go” years. For these reasons, the 4% rule may not be adequate.  

Another consideration is the need to reduce withdrawals in years when markets may be down. For instance, if the original $1,000,000 portfolio declined 7% to $930,000, the 4% rule would dictate a withdrawal of only $37,200 rather than $40,000. This is why ongoing goal planning, monitoring, and discussions with your trusted CERTIFIED FINANCIAL PLANNER® Practitioner are the foundation of a good plan for your future and recommended. With uncertainty found in economic conditions and market performance, it may be prudent to use a conservative withdrawal rate. There isn’t a “one size fits all” answer in financial planning. Your situation is unique and so is your planning. Stay focused and plan accordingly.  

The opinions expressed are those of the writer as of August 18, 2024, but not necessarily thoseof Raymond James & Associates, and subject to change at any time based on market conditions and other factors. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and investors may incur a profit or a loss. Every investor's situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment.