The 4% rule, a cornerstone of retirement planning, has recently undergone a significant update by its creator, William Bengen. Originally, this rule suggested that retirees could safely withdraw 4% of their portfolios each year without a significant risk of running out of money. However, Bengen’s latest findings indicate that retirees can now safely withdraw more than 4%, with the new safe withdrawal rate being 4.7%.
In this post, we’ll discuss why he updated the safe withdrawal rate as well as a few other surprising facts about the 4% rule that many don’t know. So, if you’re using the rule in your own retirement plan, make sure you’re using it correctly and making adjustments if necessary.
While William Bengen's revisions to the 4% rule provide valuable updates, a one-size-fits-all approach may not suit everyone. Dynamic strategies like the retirement spending smile and guardrails can offer more personalized and realistic retirement planning.
One of the critical aspects often overlooked is that the original 4% rule does not take into account investment expenses or taxes. For example, if you have a million dollars saved up for retirement, the rule suggests you can withdraw $40,000 in year 1. However, after accounting for taxes and investment expenses, that $40,000 could look a lot closer to $30,000 after taxes. Therefore, you must factor in these expenses to ensure a more accurate withdrawal rate or live with the reduced after-tax amount available for spending.
The 4% rule assumes that all your investments are in a traditional IRA, where withdrawals are taxed. It does not consider assets held in a Roth IRA or a brokerage account, which can impact your withdrawal strategy. For instance, if you have significant assets in a brokerage account, you might withdraw less from your IRA, affecting your overall withdrawal rate.
Initially, Bengen’s rule recommended an allocation of 50% to 75% in stocks, with the rest in intermediate bonds. He later revised this to a more optimal allocation of 63% in stocks and the remainder in bonds. This revision was made to support the 4% rule more effectively over time.
Bengen’s latest revision includes other asset classes such as international stocks and small and micro-cap stocks. Historically, small-cap stocks have outperformed large-cap stocks, albeit with more volatility. Including these asset classes increases the expected returns, thereby supporting a higher withdrawal rate of 4.7%.
The 4% rule is based on a 30-year retirement period. So, if you retire at 60, the rule assumes you will live until 90. However, if you plan to retire earlier or have a shorter life expectancy due to health reasons, you need to adjust your withdrawal rate accordingly.
While the 4% rule is a great starting point, my opinion is that it should not be the sole focus of your retirement plan. As a CERTIFIED FINANCIAL PLANNER™ (Not boasting - I’m required to put it in all caps), I prefer a more dynamic withdrawal strategy that aligns with how retirees actually spend their money.
The retirement spending smile comes from an extensive study done by Michael Kitces, showing that retirees spend more in the initial years of retirement when they are more active, less in the middle years as they age, and more again towards the end due to healthcare expenses. This pattern contrasts with the linear spending assumption of the 4% rule.
The guardrails strategy allows for an initial withdrawal rate higher than 4%, typically around 5% or more, depending how flexible the retiree is willing to be, since it requires flexibility to adjust spending based on market performance and portfolio balance. This approach can enable more spending in the early years of retirement, ensuring you enjoy your savings when you are most able to. Below is an income guardrails strategy with a $1million portfolio. The equivalent annual spending is $50,220 (4,185 x 12), or 5.02% - over 25% more than the 4% rule would allow for.
By clearly outlining potential increases and decreases in income based on the portfolio’s balance, this provides retirees with confidence that there’s a plan when the market inevitably turns against us. All while spending MORE money than the cookie-cutter approach that is the 4% rule.
While William Bengen's revisions to the 4% rule provide valuable updates, a one-size-fits-all approach may not suit everyone. Dynamic strategies like the retirement spending smile and guardrails can offer more personalized and realistic retirement planning.
If you are using the 4% rule, consider these updates and adjustments. For a more tailored withdrawal strategy that considers taxes, Social Security, and your true retirement goals, feel free to reach out to us for a complimentary consultation.
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