4% rule

Investing Strategies Retirement Investing
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How doe that rule work again?

The 4% withdrawal rate is that for the 1st year of retirement. 4% corresponds to the expenses we would need for a year.

for the 2nd year, I can take out that amount adjusted to inflation. So in a rising inflation environment and a dropping stock market, you would take a larger percentage of my total portfolio value. Would that be safe?

There is the question of a retirement-ready portfolio composition (40% bonds /60% stock) that needs to be setup. I did not have that proportion of bond stock- maybe more like 5/95% stock. When do you have to shuffle your portfolio to get it ready for retirement? how many years before taking the leap?

My portfolio value has hit my target value prior to the pandemic but my portfolio was and still mostly in stock, and I thought maybe I should just leave it and have it gain a bit more in the next couple of years (my idea was 2022/2023 or just about now) eventhough I did not change the composition to less stocks.
It did double from where it was and peaked at the end of last year. However, in the past 6 or 7 months, that gain has mainly evaporated so I am more or less where I was in the middle of 2020. If I had taken the leap in 2021, could I have take my amount adjusted to inflation, the 2nd year (2022)? Essentially I am down 50% in my portfolio and I would have to take a larger % of my portfolio value than the 4% taken on the 1st year.

tj

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The 4% withdrawal rate is that for the 1st year of retirement. 4% corresponds to the expenses we would need for a year.

for the 2nd year, I can take out that amount adjusted to inflation. So in a rising inflation environment and a dropping stock market, you would take a larger percentage of my total portfolio value. Would that be safe?

The whole point is that it’s safe (historically).

Take 4% the first year. Then forget you ever heard about the 4% rule.

The second year, year-over-year inflation was say 7.04% (CPI-U). So, with $1 million portfolio, take $40,000 the first year, and then $42,816 the second ($40,000 x 1.0704), and so on.

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"How doe that rule work again?

The 4% withdrawal rate is that for the 1st year of retirement. 4% corresponds to the expenses we would need for a year.

for the 2nd year, I can take out that amount adjusted to inflation. So in a rising inflation environment and a dropping stock market, you would take a larger percentage of my total portfolio value. Would that be safe?"

The 4% rule comes from multiple studies that examine portfolios for 30 year survival rates.

If you start with a 60/40 portfolio, there is very high probability you can take 4% per year, inflation adjusted and not run out of money - with one assumption - that the market is no worse than at any time in history.

Now…you will have to pay TAXES …depending whether it is tax deferred or not - and that determines the level of taxes.

If all your assets are in a 401K/IRA, then you can withdraw them at some point with no penalty - but you pay REGULAR income tax rates. For many this is low… but you still may owe some tax on it. If you collect SS (up to 85% taxable), it is on top of that - for determining the tax bracket.

thus, your ‘income’ even if you take 4% of your portfolio the first year… is reduced by taxes (Fed and state taxes).

If your savings are either regular stock market account or a ROTH IRA, that is different. You’ll pay capital gains on stocks (and their dividends) as you take money out. If you own dividend paying stocks (not tax deferred) you’ll pay annual tax on that - like you currently are if you own dividend paying stocks.

So…get out your calculator and figure what your tax bill will be. Then you can know what your after tax take is.

Yes the market could go down 20% more after you start your withdrawals. Some like to have 5 years set aside in bonds/CDs/etc laddered to counter the ups and downs of the stock market as part of their “40%” bonds.

If you are ‘marginal’ in income and sweat what would happen if the market tanked even more - consider working a bit longer.

If you can , defer SS to age 70 to maximize yearly take from SS. That is increased annually with inflation.

t.

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How doe that rule work again?

The 4% withdrawal rate is that for the 1st year of retirement. 4% corresponds to the expenses we would need for a year.

for the 2nd year, I can take out that amount adjusted to inflation. So in a rising inflation environment and a dropping stock market, you would take a larger percentage of my total portfolio value. Would that be safe?

Assuming that you are planning for your portfolio lasting no longer than 30 years, and the markets don’t deviate outside their historical performance, then your portfolio should last for the length of your plan.

There is the question of a retirement-ready portfolio composition (40% bonds /60% stock) that needs to be setup. I did not have that proportion of bond stock- maybe more like 5/95% stock. When do you have to shuffle your portfolio to get it ready for retirement? how many years before taking the leap?

I’ve often seen it suggested that you should do a gradual transition starting 3 - 5 years before you plan to retire. But I’ve also seen people that do it all at once, when they, for instance, roll their 401(k)s to IRAs and buy different investments in the IRA. Just depends on how much risk you want to take that you will be selling investments in a down market.

It did double from where it was and peaked at the end of last year. However, in the past 6 or 7 months, that gain has mainly evaporated so I am more or less where I was in the middle of 2020. If I had taken the leap in 2021, could I have take my amount adjusted to inflation, the 2nd year (2022)? Essentially I am down 50% in my portfolio and I would have to take a larger % of my portfolio value than the 4% taken on the 1st year.

Looks like the risk of your portfolio allocation bit you. Now you need to decide how to recover. Spending less may need to be your answer.

AJ

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Now…you will have to pay TAXES …depending whether it is tax deferred or not - and that determines the level of taxes.

Taxes should have been accounted for when determining what you needed your withdrawal amount to be to determine if an initial 4% withdrawal will be sufficient. If taxes were not included in the living expenses during retirement, you may not be able to maintain the living standard that you were planning on.

AJ

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Any income such as social security or pensions reduces the amount of draw necessary from savings to cover your expenses.

For example if you need $75k to live on, and you have $35k in social security, then you need $40k from savings to make your nut. If $60k is your safe withdrawal rate, you can either increase your spending by $20k, withdraw $20k less, or something else.

My wife (spender) and I (saver) usually split the difference, spend 1/2 the next year and save 1/2 for future down turns.

Jack

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The 4% withdrawal algorithm everyone is describing has a 95% historical success rate. Not 100%. There are failures. You’ve zeroed in on how the strategy fails: start withdrawals and then experience a big long market drop. In most retirement years, the market recovers enough that the portfolio survives. But if the drop is big enough and long enough, and if inflation conspires against you, the strategy does fail. Sounds a lot like today but maybe the market will recover soon enough for the portfolio to survive. If I had retired in January 2022 I would be thinking about cutting my withdrawals until the market recovers.

The last retirement date with 30 years of data is 1991. If you retired in 1991 with $1M and followed the strategy you ended last December with $6.5M. The failures are for retirements in 1964 through 1969. The bear market and inflation of the 1970s were killers. All other retirement years going back to 1871 were success. I pulled this from https://www.cfiresim.com/. You can play around with the numbers there very easily. Note that the success of an allocation of 95/5 is not that different than 60/40. I would probably move to 60/40 but not rush it and consider tax consequences of selling.

The upside is that 95% of the time you do fine and 50% of the time you end up with more money than you started with.

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We retired this year. We have about 2 years in cash. After that, we’ll have to start dipping into investments. Yeah, the market drop correlates to another action on my/our part. It’s uncanny.

Trying not to do that until the market clearly is recovering.

Also entertaining the idea of paying off the house. We’re at 3.375%, but that’s a better return on $25K than we would get anywhere else right now. If we don’t pay it off now, we’ll still end up paying it off next year (about 12 months) just by making our regular payments.

1poorguy

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Also entertaining the idea of paying off the house. We’re at 3.375%, but that’s a better return on $25K than we would get anywhere else right now. If we don’t pay it off now, we’ll still end up paying it off next year (about 12 months) just by making our regular payments.

It’s kind of funny that we’re heading in opposite directions on this one. But, I’m sure our circumstances are a bit different. We paid off our house early around 15 years ago, while still earning income. It worked out fine for us, but perhaps not the optimum strategy.

Now, 2 years into retirement, we are in the process of buying a new place and will be obtaining a mortgage for that at higher interest rates than we’d like, but not the worst we’ve seen. We’re doing this rather than dip into our currently depressed investments for a cash offer. In the short term, we’ll be able to use investment income, savings and sell off assets gradually to make the mortgage payments. If things go according to plan, we will be selling our current place within the next few months, so we’ll have a big chunk of change to invest once that closes. If we’re really lucky, we’ll hit something near the low point for the stock market just as those funds become available to invest. Then, long-term, we can use the investment income from those additional funds to pay the mortgage and more.

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My wife (spender) and I (saver) usually split the difference, spend 1/2 the next year and save 1/2 for future down turns.

He, he, he. I hear ya man. You should see our monthly QVC invoice. Grin.

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William Bengen wrote “the” book on this. (He discovered/invented the 4% rule.) His book is available on Amazon.

Your portfolio is actually outside the range of holdings Bengen says his rule will work with. You might want to look into the details.

What inflation factor you use matters – it is not your personal inflation or the Headline number. It is more like the “ex energy and food” number.

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There are a few ways to view the current drop if you are a recent retiree or were planning to become one.

First, obviously if you had a $1M portfolio and was planning to withdraw $40K a year and now your portfolio is $800K the numbers are now $32K which has to hurt. Or if you retired last year and started withdrawing $40K and with the high inflation might want to withdraw $42K+ but your portfolio is now at ~$800K, it is now 5%+ withdrawal.

That certainly would concern me and anyone who doesn’t have a pension or other fixed source of income.

Or you can view it, if you were planning to retire shortly, as going forward the expected returns are hopefully higher now, than they were at the start of 2021 since stocks are (hopefully) much less overvalued.

Obviously if you aren’t close to retiring, it should just be full speed ahead and ignore the noise (hopefully just noise).

As someone who hopes to retire this year or next, I’m not sure how to view things right now. Grateful I wasn’t 100% in stocks/bonds and I also will have a pension (maybe 25-30% of my needs) and can still delay social security to FRA for my wife and either FRA or 70 for me.

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Hi thejusticier,

I used the 4% guideline initially when planning for retirement but have not used it since. Why?

Using a guideline like this to plan annual withdrawals just goes against the way I use our portfolio to live on.

I do not use a calendar to manage money, our portfolio and in particular, withdrawals.

As I mentioned before. I use an expense cash cushion that is separate from our portfolio. It is not invested in any way, shape or form. I have a target value of the next 3 years of anticipated cash needs. Anything I intend to buy with cash from our living expenses, taxes, mortgage payments, etc plus any special purchases like the house we are building.

I push cash from our portfolio to the cash cushion only when I decide that is the best use of the cash.

Unless I sell stock for specific company reasons, I do not sell when markets are down, like they are now.

The cash cushion keeps our check book filled for a minimum of 3 years.

I can supplement the cushion by using dividend cash since it does not require a sale of securities.

A few years ago, our bond position was about 10%. Right now it is 0.87% in BIV. Additionally, we have 7.72% in interest bearing annuities at 4.5% APR.

Having our expense cash cushion has been crucial to keeping our investments intact during down turns in the market.

Something to note about the above: The important point is not selling during down turns. You can sell and let the cash sit in the accounts. I have a lot of our house money still in our Roth IRA’s because I do not know how much of it I will need.

In short: Managing our cash using a cushion and how we create cash makes these down turns inconsequential to our spending. The cushion creates a buffer between our portfolio and our check book.

Does that help you?

Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx

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yes but in a high inflation environment, doing so will reduce the time one could do that safely.
Originally the 4% rule was for a 30 year retirement? If the inflation level is higher in that period, would I not run out of money near the end?

tj

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I used essentially my current salary=4% of my portfolio. For the most part I want to be able to earn my current salary adjusted by inflation in retirement. I have kept my expenses somewhat less than my salary and have been saving ~1/3 of it each year (~1/3 to taxes and ~1/3 expenses). However, I am looking at 40-45 years rather than 30 years survival time.

I can certainly look into taking less during bear years (or nothing depending on how much cushion I would need to maintain), and consider taking out more during bulls to replenish this 3-5 years money cushion. What is the recommended cushion in the scheme?

I definitely may need to change the composition of my portfolio for retirement. The volatility especially these past 6 months has been extreme. I want to tone it down and increase dividends. REITs are interesting to me in that regard.
Is there a summary of the guidelines on MF I can review?

tj

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I used essentially my current salary=4% of my portfolio. For the most part I want to be able to earn my current salary adjusted by inflation in retirement. I have kept my expenses somewhat less than my salary and have been saving ~1/3 of it each year (~1/3 to taxes and ~1/3 expenses). However, I am looking at 40-45 years rather than 30 years survival time.

If your taxes stayed the same, then you only need 2/3 of your salary since you won’t be saving 1/3. Why withdraw money only to reinvest it? 2/3 of 4% is 2.67%. Your taxes should be lower for a number of reasons. You might want to estimate your projected taxes in retirement. If you have SS or any other source of income, your withdrawal requirement will be even lower.

Safe withdrawal rates for longer retirements are more uncertain because there are fewer 45 year periods in the past than 30 year periods. But generally, I hear people talk about 3% being the SWR if you want your portfolio to last forever. You can play around at https://cfiresim.com/. I would sleep very well at night with a 2.67% withdrawal for 45 years.

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“I used essentially my current salary=4% of my portfolio. For the most part I want to be able to earn my current salary adjusted by inflation in retirement. I have kept my expenses somewhat less than my salary and have been saving ~1/3 of it each year (~1/3 to taxes and ~1/3 expenses). However, I am looking at 40-45 years rather than 30 years survival time.”

One of the big costs in retirement is health insurance. If you’ve got a way to get that…great…otherwise, until age 65, you are on your own in a not great individual insurance market - especially if you have ‘existing problems’.

When you retire - almost 10% of your taxes disappear. No more FICA and FICA II for SS and Medicare tax.

Depending upon where your portfolio is stashed, your income tax rate maybe be a lot lower if you have ‘capital gains’ and ‘dividend’ income rather than salary. 401K withdrawals are taxed at same rate when you worked…except no SS and Medicare tax.

Once you get to SS age, that is a ‘guaranteed’ and inflation protected part of your income stream. There for as long as you live. Best to defer to age 70 if you expect to live to 100…

If you’re living on 1/3rd your salary, I don’t see a need for you to have your ‘regular income’ type income unless you plan lots and lots of spending. Just cutting out retirement savings (that 1/3rd of salary)…doubles your existing expenditure rate.

with the market uncertainty, inflation out of control, I wouldn’t want to be planning to take 4% out of my portfolio if I were to retire now. I retired 23 years ago…so far so good.

t

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For the most part I want to be able to earn my current salary adjusted by inflation in retirement. I have kept my expenses somewhat less than my salary and have been saving ~1/3 of it each year (~1/3 to taxes and ~1/3 expenses).

Not sure why you would want to withdraw the value of your entire salary if your expenses and taxes are each only 1/3, and you would no longer need to fund the savings. Not to mention that by not having to pay SS and Medicare taxes on your income, the amount you pay in taxes should also drop. Unless you are planning on nearly doubling your expenses, you should be able to fund your retirement with withdrawals that start out as significantly less than your current salary.

However, I am looking at 40-45 years rather than 30 years survival time.

That would probably call for closer to a 3% initial withdrawal rate. You can run your own scenarios at firecalc https://firecalc.com/

I can certainly look into taking less during bear years (or nothing depending on how much cushion I would need to maintain), and consider taking out more during bulls to replenish this 3-5 years money cushion. What is the recommended cushion in the scheme?

Well, that’s the thing. If you want to maintain, say, a 5 year cushion outside of your portfolio, but you have 3 bad years in a row, you’re going to be down to a 2 year cushion - so you aren’t really ‘maintaining’ a 5 year cushion. Personally, I count my cash as part of the bond part of my allocation, and readjust within that.

Is there a summary of the guidelines on MF I can review?

What guidelines are you looking for? I gave you a link to the REIT board in an earlier post.

AJ

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?First, obviously if you had a $1M portfolio and was planning to withdraw $40K a year and now your portfolio is $800K the numbers are now $32K which has to hurt. Or if you retired last year and started withdrawing $40K and with the high inflation might want to withdraw $42K+ but your portfolio is now at ~$800K, it is now 5%+ withdrawal.

With rising inflation, it’s a double-whammy. Where $40K was looking sufficient to meet your needs a year ago, you now might need $43K instead. Double ouch.

I’m retiring in September, and while things still look OK, the numbers aren’t looking as good as they did in January. I’ve always expected that when I retire it would turn into one of the bad financial times to do so (it’s in keeping with my timing on my few other major financial moves) so I factored in some cushion, but it’s not as much as it was. I’m still going ahead with my retirement plans, but will be more cautious for a while about spending money.

Or you can view it, if you were planning to retire shortly, as going forward the expected returns are hopefully higher now, than they were at the start of 2021 since stocks are (hopefully) much less overvalued.

There is that, although stocks as a whole still aren’t exactly cheap.

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How doe that rule work again?
The 4% withdrawal rate is that for the 1st year of retirement.
…Essentially I am down 50% in my portfolio and I would have to take a larger % of my portfolio value than the 4% taken on the 1st year.

The 4% study assumes a certain stock/bond allocation, and doesn’t necessarily apply to any asset allocation, or any selection of stocks or stock funds. If you are down essentially 50% when the SP500 is down 24% and the bond market (using the AGG) is down 14%, then your portfolio is not made up of the things that were used in the study.

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