The 4% Rule Is Dead! No It's Not!

The 4% rule isn't an endpoint, it is a starting point.

Monevator had a post describing why the 4% rule does not work. Included in their reasoning was it doesn't account for taxes and that the back tests only look at 30 year retirements when they can be longer. The "safe withdrawal rate" of 4% in the US is lower in other countries using the same process that gets us to 4% here; it was 3.36% in the UK, 1.01% in Germany and 27 basis points (yikes) in Japan.

It may not consider taxes and maybe 30 years is too short for planning purposes but I think the bigger threat to the 4% rule is that it is built on total returns from the bond market that do not exist anymore. In subsequent decades I suppose that opportunity could come back but there is no visibility for when that might happen. For anyone new, interest rates dropping from double digits to zero over the course of 30-ish years created massive gains which are built into the results underlying the 4% rule.

Despite all of that, I think there is a different and much more productive way to look at the 4% rule. It is a building block of understanding for withdrawal rates. A 4% withdrawal rate has a better than 90% probability of working out (not outlasting your money). Once you understand the basics then you are making a more informed decision about any deviation away from 4%.

The 4% rule might also be too simplistic for several reasons. The first one is that life's spending needs are lumpier than needing the same percentage every year. My wife and I bought the house we live in back in 2012. When we bought it, it needed a lot of work and we spent the money. It was a lot but made the house much easier to live in, it was worth money and the work was needed. This year we are now getting more work done. It is fairly extensive but much less than seven years ago. Large outlays like this every few years, ten years, whatever are very real life things and not extravagances but in this case protecting our shelter and our asset (the value of the house). If you are spending a lot of money every year like this then you might run into problems but hopefully your financial/retirement plan can withstand these as occasional expenditures.

My understanding of the 4% rule is that at the conceptual level it tries to allow for these types of one-off expenses. If you're 70 years old now and been retired for six years taking just 4% every year but this year you need to take an extra $12,000 for something major with your house or a child's wedding (have a client doing that later this year) or some sort of trip of a lifetime the discipline of 4% all those other years hopefully allows for the extra withdrawal.

Also part of the lifestyle arc is the idea of spending more as a younger retiree for being more active (probably) at 65 than you are at 80 (more on that below). We touched on this the other day and while everyone is different there comes some age where we do less which means we are probably spending less.

Another obstacle to 4%, sort of, is the extent to which most people have different types of accounts. The building block for the order in which you take money from is taxable account, traditional IRA and then Roth IRA. Again, that is the basic starting point and it should be understood thoroughly. There are limitless individual circumstances why someone would do it differently but you make a more informed decision about deviating once you understand the basics.

Just sticking the basics for this post, if you have all three types of accounts then you're likely to deplete your taxable account before starting in on the IRA and that might be very uncomfortable. The idea is that the IRA continues to grow tax deferred and if you're paying taxes based on your qualified accounts then it would mostly be capital gains which are usually lower than income taxes; so usually more tax efficient. If you have $200,000 in a taxable account at $700,000 in IRAs and you're just taking from the taxable account, 4% of $900,000 is $36,000 but that is a much larger percentage of $200,000, so again potentially uncomfortable. If you trust the numbers and the basics fit your situation then you're kind of all set in terms of what to expect. If you don't trust the numbers then this is where some sort of monetized hobby can come in so that you are taking less than $36,000 from your portfolio or you could downsize your home such that you add to your portfolio and so on.

Another way that I have come at this in the past is a deviation from the 4% rule as follows. The 4% rule says take 4% in year one and then increase by the rate of inflation each year. This never made any sense to me and Monevator questions how many people do this. My thought has been whatever you got, 4%. A little more specifically, whatever you got, 1% every three months. The upside is that technically you'd never run out of money (keeping it simple and that you don't have to spend everything on lifesaving medical treatment that isn't covered). The downside is that the income available from the portfolio could swing widely from year to year. In 2007 maybe you could have taken $41,000 but maybe the following year it was only $32,000. Is that too disruptive? For some people yes but others no, it just depends.

You probably have not gotten this far into the post and think oh yeah, this sounds easy. It is a challenge to overcome or a problem to solve. The problem solving aspect to all of this is why I write so many posts about lifestyle, health and spending. I regularly talk about how living below your means and doing what you can to increase your healthspan (similar to lifespan but relates to being able bodied for longer) makes every other aspect of your life easier including implementing your retirement plan.

Up above I mentioned slowing down at maybe 80. I went to the gym very early today to be back to watch the NCAA Tournament at 9am. A dude in his late 60's who I've seen there off and on for years was working out, not heavy weight but not light either and he looks pretty good for late 60's not elite but pretty good....found out he's actually 80. Staying active and lifting weights is crucial to successful aging.

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