New Study UPDATES the 4% Withdrawal Rule – Can You Spend More in Retirement?

Does the 4% withdrawal rule still work in today’s retirement landscape? You’ll learn how inflation and market volatility have challenged the original estimates that created this popular retirement rule. We’ll compare the 4% rule to newer withdrawal strategies that adapt to changing markets and retirement needs.

Resources:

- Alliance of Comprehensive Planners: https://www.acplanners.org

- John's firm website: https://www.trinfin.com

- Find us on Facebook: https://www.facebook.com/friendstalkfinancialplanning

Check out the study mentioned in this video: https://ofdollarsanddata.com/why-the-5-rule-is-the-new-4-rule/

TRANSCRIPT:

Bridget: John, let's talk about safe withdrawal rates. There's been a lot of research and thought about what safe withdrawal rates are. That means how much of your portfolio or your money can you take out each year? And I know you've got a lot to say about it, and there're recommendations all over the board. And let's try to help people make sense of this. I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois.

John: I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. And before we jump in and start talking about safe withdrawal rates, I want to remind everybody to hit that subscribe button. Give us a like and let other people find this stuff on YouTube. And in many cases, Bridget, rules of thumb or guidelines are not super useful. But this is one I think actually is really useful. And I love how you described it in the intro.

How much can I take out? That’s what people want to know. How much do I need so I can take out the stuff I want to take out and live the life I want to live. I guess that’s retirement planning at its most fundamental. What is that number? Historically, I think this goes back into the 1990s, a guy named Bill Bengen did research and looked at various market cycles going back 80 or 100 years and said, what if I just have half stocks and half in bonds. How much can I take out and never have to worry about running out of money in all those cycles? And he came up with basically 4%.

And so, in our world, that's been known for 20 plus years as the 4% rule. You can take out about 4% of your money. And what does that 4% means? We were just talking about it a little bit earlier before we hit record, and I'll use some round numbers because I can do math more easily. If I have a million dollars and I'm going to retire, I can take out 4%. So 4% of a million is $40,000. That's my starting withdrawal rate. And then I take that $40,000. I don't care how much my portfolio changes; it can go to $10 million; it can go down to $100,000. I take out $40,000 a year, every year, and keep it up with inflation. Yeah. Jump in.

Bridget: Okay, so stop here. So, first year, easy calculation, right? We got a million bucks, so we're taking out $40,000. Now, year two, let's say it's still a million bucks, but inflation is 2%. Do I take 2% of the million?

John: No. 2% of the $40,000.

Bridget: Okay, the $40,000.

John: Yep.

Bridget: So that means $40,800, is that right?

John: Yes, so my spending goes up with inflation.

Bridget: Yeah. But it's just that amount. It's not 2% of the whole.

John: Yeah. And that's a really important point.

Bridget: So if the next year, it's 3% inflation, then I take the $40,800 and multiply it 1.03, and that's how I get my next rate.

John: Yep, that's a great explanation. Sometimes people a mistake and say, “Oh, I get to take 4% of my portfolio, my money, every year.” That may be practically how we do things, but that's not how this methodology measures things.

Bridget: That's not how they came up with it. That’s now how this research worked.

John: And think about this inflation thing. That's a really great point. So for people who are getting Social Security, you get $2,346 a month. And then a year from now, Social Security says, “Hey, inflation is 2.8%.” Well, then they take 2.8% more. So your Social Security goes up by that. Your payment goes up by that inflation amount. And Social Security does that for us. That's how this study has been done as well.

So if you were actually going to do this in practice, you have to do some convoluted math every year to figure it out. So it's important to know. This is not a suggestion to do this math every year and follow this rule exactly to how the research was done. But it's important to know how that research got done so you can go, “Oh, this is what they're talking about when they talk about this.”

Bridget: Right. So the research that you were talking about said that there's a new study that says, “Gee whiz, probably 5% is fine.”

John: I don't think that they actually said gee whiz in the study, but they might have😊 So Bengen, the same guy, came back and said that the 4% rule he came up with so that in all circumstances you never ran out of money. So it's not necessarily the rule to use. That just means there's zero chance in any of his research that you run out. Maybe you could take out some more than that if you're willing to be flexible on things.

So then in the last couple of years, he wrote a new book and he said, “I looked back on these things and rather than just using S&P 500 and bonds, what if we had a more diversified portfolio (like you and I would put together for clients)? And what if we had some small company stocks? What if we had some international stocks? What if we had some cash and bonds and really made it what we would consider a diversified portfolio and ran the same calculations? With a diversified portfolio, what's our starting rate? What is our starting percentage?” And he came in with something along the lines of 4.7% or just under 5% as the safe withdrawal rate.

Bridget: And safe meaning it works 100% of the time.

John: 100% of the time. And we'll put a link in the show notes here. There's an article that has some graphics and things At 5%, it's 98% of the time. At 4.68%, it's 100%. So I like round numbers. Around 5% means you never have to change that pattern.

Bridget: Right. It doesn't matter if there's a huge recession and nobody wants to spend any money. So what?

John: You keep on doing that same thing every year.

Bridget: Yeah.

John: And that's a great point with this whole thing. As you just said, what if we go back to ’07, ’08, ’09, when there was a huge recession. And this says is, “I'm going to keep increasing my spending no matter what happens to my portfolio. If it gets cut by 40%, I'm going to keep on spending more and more and more every year.” That's not how most of us work in reality. We usually think, “I'm willing to pull in my horns a little bit if things change. But I just want to point out another thing.

We go, “Oh, it was 4%, now it's 5%. Big deal. What's 1%?” Well, if you think about going from 4% to 5%, that's actually a 25% increase in spending. That's like going from $40,000 to $50,000 a year. That's a big jump, right? It sounds like only 1%, but that's a big change in spending. And there's zero risk of running out of money, at least historically speaking. We can take a look at that little chart, and if you go to 6%, that means that 75% of the time you did not have to make any changes whatsoever.

Bridget: And that’s 6% plus inflation.

John: Right, including inflation. That's adjustable. 6% to start and keep up with inflation.

Bridget: So you could increase your spending by 9% a year.

John: It happens. And so, 75% means that, hey, three out of four times, you don't have to change. That means one out of four times you might have to make a change down the road. Oh, wait a minute. It's not one out of four times you run out of money and crash a plane into the mountain. It's one out of four times you need to make some adjustments. But in exchange for being willing to be flexible, you get to take out 50% more than we were talking about before. Oh, yeah, that kind of makes some sense.

Bridget: Yeah. So, can I start talking about my problems with this way of thinking?

John: Absolutely. Tell me your problem, Bridget.

Bridget: All right, let me tell you my first problem. It really doesn't optimize your life in retirement, because typically, people enjoy spending more when they're at the beginning of retirement. And once they get to 80, if they're lucky enough to make it to 80 or 90, and not everybody does, then it's more like been there, done that.

Now, you don't want to run out of money there, or you don't want to need a lot of care and not be able to afford it. But as you get older, the chance of needing a lot of care and not being able to afford it diminishes, because how long are you going to live? You have less time to live. So it's not optimizing your living. It's just trying to be steady.

John: Yeah.

Bridget: It’s trying to make a world that's just steady. And so, what I see with people is some years people want to take their big trip. They want to have a big celebration for their anniversary for their whole family. And so, they spend a lot. They spend more than my 6% plus inflation. They just spend a lot that year, but then the next year and they don't; it goes down. Then the next year, there's an illness, and they don't spend anything really, because they're at home just trying to recuperate. And everything's covered by Medicare. So my problem with these kinds of rules that it doesn't take into account how you're actually living your life.

And I think people need to grapple with one particular issue and that is are they going to feel a lot safer and have a lot better sense of security and sleep better at night in retirement if they never spend down their nest egg? So they retire with 2 million and they add 2 million. Or are they willing to spend on some of their nest egg? Are they okay with that? The problem with the 2 million people is that they don't take out enough. It keeps growing. And then they’re in their 80s trying to figure out whom to donate to, whom to give money to. That can be okay, but for a lot of people it's really not optimal.

John: Right.

Bridget: And then their kids say, “We're fine, mom or dad, we don't need this. All this is giving us a lot of complications.” So those are the things that I'm curious about. Do you actually have a conversation with people, and do they even have the self-knowledge to know when they retire?

Because a lot of times your opinion changes as you go along. Am I comfortable spending down this money, or do I need to keep my nest egg intact? I don't want to spend it, I don't want it to go lower, and I'll just take whatever on the top that year. Because I think from a practical standpoint, that's what people really do.

John: Yeah, you might be surprised to find out that I agree with you on this. I think this is a terrible way to handle spending in retirement. But I think it's a great way to figure out, hey, am I in a position where I can retire and this will work?

Bridget: That’s a good point.

John: Do I have enough? When will I have enough? Well, how much do you think you're going to spend your first year of retirement. I'm going to spend this much money. All right, then take Social Security. Well, if I can take out 5% or 6% or something. 4%, 5%, 6%. All right, I need to have about this much money to produce the money. Okay, good. I'm on track. I'm in a position where that gives me a target for retirement. Getting into retirement is a whole different story.

I don't think it works at all for the reasons you just described. It just doesn't work. But for the idea of, well, how much do I need? How do I know when I'm able to retire? What's my target? That's where I see this as being useful when I talk with a new client or a friend. Well, tell me, how much do you want to spend? How much do you have? Okay, I can kind of tell you. Yeah, you're in pretty good shape. You can retire when that kind of math works out. But then doing it, that's where the skill comes in, that's where the rule of thumb doesn't work.

Bridget: So you say, “Use it before to estimate when you can retire.” And then once you retire, you say, “Okay, we’ve got to think about this differently.”

John: Then you got to dig in. Then it's different for everybody. The rule of thumb is good to estimate. Hey, am I on track? What's my target? What's with some of those big companies? What's my retirement plan? That gives you your number. You don't need whatever little path. Use that rule of thumb, then make sure that you make it specific for you, for your goals, for your emotions, all those things that you just described.

Bridget: Cool. Well, it's a great time to wrap it up. I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois.

John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are taking on new clients. We'd love to hear from you if you like what you hear on our show, but if you'd like to find somebody in your area who thinks like us, we're both members of the Alliance of Comprehensive Planners, and you can find an advisor in your area at acplanner.org.

Bridget: Don't forget to subscribe.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation.  We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.