The Stunning Problem With The 4% Retirement Income Rule

The Stunning Problem With The 4% Retirement Income Rule

February 28, 2021
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Risky Years

Are you in the “retirement risk bubble”? The retirement risk bubble is the few years leading up to retirement and the first few years in retirement when your retirement nest egg is most vulnerable to market shocks. Why? It is because of sequence of investment returns risk. Sequence of investment returns is most dangerous when you are withdrawing money from your portfolio, which is exactly what most retirees need to do in retirement. According to researcher Wade Pfau, the sequence of returns risk profile has the following shape, clearly indicating the riskiest years:

The 4% 'Rule'

William Bengen first wrote about the 4% rule in a 1994 research paper for the Journal of Financial Planning called Determining Withdrawal Rates Using Historical Data. This is often called a 'systematic withdrawal' approach to retirement planning. He proposed a safe withdrawal rate of 4% of a portfolio’s value in the first year of retirement, an amount which is used as a baseline for spending going forward. 


Each year thereafter, you would increase that initial amount by the rate of inflation so your spending keeps up with the cost of living.


Retirement nerds have been running Monte Carlo simulations and debating the merits of Bengen’s 4% rule ever since, and it seems almost to have seeped into the DNA of retirees as a valuable and infallible tool. 

According to many peoples' thinking, the 4% retirement rule will protect them...but is that really true? The short answer is yes, it does provide some protection. Based on the research used to develop the 4% rule, it was found that an initial withdrawal of 4% from a portfolio was the highest withdrawal rate over the time period analyzed that didn’t leave the retiree broke after 30 years of withdrawals. Does this mean you are guaranteed to never run out of money in retirement if you rely on the 4% rule? Absolutely not!

The following short video is an analysis of this 'rule' using actual market data...

Note the average return over the timeframe chosen (last 30 years) is 9.11%. Most people today would be happy with that return.  

BUT, we really don't know what is going to happen in the market...what does it really mean in practical terms?

Here we see a huge range of possible outcomes...from having over $6 million to spend in retirement to only having only $0.9 million and running out of money at age 81 - 16 years into retirement!

The difference between Accumulation math and Distribution math is that 'dollar cost averaging' works against you in retirement. 

We have to be more diligent if that's the account we are depending upon to live. We could get into the financial death spiral, where it's mathematically impossible to get those losses back...and, referring again to the first graphic, this risk is greatest in the several years leading up to and just after beginning retirement. 

We simply cannot depend upon this outdated and overly simplistic 'rule' for retirement planning. The people I work with want more predictability for their retirement plans than this systematic withdrawal approach. This is 20th-century retirement planning; we are in the 21st century, and we have to use better methods.

Work with the modern retirement planning team. Learn how to properly manage the risks of retirement, with modern, safety-first planning.

Do you know the answer to the 4 Toughest Financial Questions we all face?

  1. Do you know what rate of return you need to earn doing what you are doing today to be able to retire at the same standard of living you enjoy today?
  2. Do you know how much you need to be saving each year to be able to live in the future like you live today?
  3. Do you know how long you will have to work before you can retire and have your money last to life expectancy?
  4. Do you know how much you will have to reduce your standard of living at retirement if you don’t do something now?
    • Would you like to know?

 In 15 minutes, I can answer those 4 questions for you, and you will be able to determine if what I do can be of help to you.

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