Why the Demise of the 4% Withdrawal Rule Shouldn’t Worry You

by David@MoneyNing.com · 4 comments


Many of you know about the 4% retirement withdrawal rule, which claimed that a retiree can withdraw 4% from their nest egg each year, adjust the amount for inflation, and have it last for 30 years. The 4% rate is pretty much the gold standard when it comes to retirement planning since the Trinity report was published in 1995. You may also have heard many experts claim how 4% is no longer safe because the study was based on stock market history and how the stock and bond portfolio that the nest egg needed to be invested in won’t provide nearly the same return as what history has provided us. That can only mean one thing – a lower withdrawal rate.

I’ve spoken to many of you about this because the reasoning is undeniable. I mean, bonds used to provide good single-digit and at times double-digit returns in the past. The 10-year treasury is expected to return roughly 1% a year these days. Stock prospects aren’t faring much better. The vast majority of metrics people use to value the stock market is flashing warning signs of how everything is severely overvalued.

It’s scary, especially when some are now saying that 2.5% is the new withdrawal rate. Now 1.5% may not sound like much, but changing the withdrawal rate to the lower number means a 37.5% reduction in spending money in retirement. You can try to save more to keep the same retirement income, but we are talking about having to accumulate 60% more in savings. That’s working years if not decades longer.

So what are soon-to-be-retirees to do? Luckily, the situation isn’t nearly as dire as the doomsayers are claiming. Here are a few reasons why:

Your portfolio grew a ton lately. The reason why stocks and bonds are forecasted to have lower returns going forward is that the market has been on fire for the past few years. The S&P 500 returned 18.40% in 2020, following 2019 when the index returned 31.49%. Chances are high that your nest egg is much bigger than you thought it would be. When you compare a scenario where the market was flat for two years, you’ve already accumulated that extra 60%.

4% covers the absolute worst case in history already. This is a big one. 4% isn’t the average withdrawal rate. You might be encouraged to hear that there’s a 96% chance you will have more money left over after 30 years of withdrawal if you stick to the 4% rule. In fact, taking 4% leaves you extremely rich on average. Taking 4% and increasing withdraws to account for inflation doesn’t deplete your portfolio during the worst 30 years of history. It was safe to withdrawal through the great depression, it was safe during the two world wars, and it was safe during the hyperinflation years.

Lower returns don’t automatically mean a lower safe withdrawal rate. Sure, lower returns put pressure on the withdrawal rate for obvious reasons, but stocks returned 10% annually in the long term and the safe withdrawal rate is 4%. There’s plenty of room for returns to be lower without putting the withdrawal rate in danger. The reason why the withdrawal rate is low at 4% and not closer to historical returns isn’t because of the lack of returns, but the volatility of these returns. Stocks, even bonds can have good years and bad years. Stocks in particular can have really bad years, like 1929 when the S&P 500 returned 74.6%. Couple this with ever-increasing withdrawals and that’s why the rate needs to be lower. In general, retirees who encounter negative return years early on in their retirement are the ones who run into the danger of running out of money. The risk of being among these retirees is known as the sequence of return risk.

You can significantly lower the risk of depleting your portfolio prematurely by being flexible with your spending. There are plenty of other withdrawal plans that let retirees withdraw more than 4% initially as long as they have flexibility with their expenses. Variable Percentage Withdrawal (VPW) starts at the mid 4%s and Guyton-Klinger promises withdrawals in the 5% range. There are limitations on each plan, but the takeaway is that being flexible really works. Plus, the vast majority of sane retirees will likely tighten their belts a bit when markets perform badly anyway. That’s great news.

All the worriers of the 4% rule are using current market conditions to raise alarm on what the reasonable sustainable withdrawal rate should be these days. They make valid and scary points for a retiree and whether they can withdraw 4% today if they were to retire and still have their portfolio last for at least 30 years. But the reality is that unless you are retiring today, none of these predictions apply to you at all. All these return metrics that people use to predict the future can at the most look out ten years even if it’s 100% accurate (and it’s not even close to being accurate). When you are talking about long term returns, it has everything to do with how the economy evolves and how companies based in that country can take advantage of the new trends. No metic will ever come close to figuring that out.

Everyone’s Crystal Ball is Cloudy
It’s possible that the people predicting 4% to no longer be safe is right one day. Sure. But it’s even more likely that they are dead wrong. The doomsayers have been predicting that the safe withdrawal rate needs to be lower for years now. But with the incredibly good returns of stocks and bonds of the past few years, the opposite became true. Retirees of the past few years seriously shortchanged themselves if they spent less, and you run the risk of doing the same if you are overly worried.

Stay flexible, but optimistic. That’ll serve you well in retirement.

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  • Edward Grozalis says:

    And then there’s social security…
    If you take out 4% and then reduce it by your social security benefits at 62+ your money will last even longer than 30 years. I’m assuming you can live on about 50-60k a year for a married couple.
    I can’t see social security going away, too many people depend on it, and since we paid into it we should get some benefit from it.
    I think 4% is reasonable, maybe even 5% when you include social security.

    • David@MoneyNing.com says:

      Thanks for reminding me about social security. Those who are closer to 65 have the best pension available to mankind via the government program.

      • Edward Grozalis says:

        Let’s just hope the government does something to keep it solvent. The longer they wait, the worse it gets. I hope the new administration does something.

        • David@MoneyNing.com says:

          There’s zero chance the government would just let it blow up. Even if no one does anything, it’ll be like the debt ceiling where they keep kicking the can by patching the rules so they can keep digging the hole.

          But I agree with you – let’s hope this administration does something and hopefully it won’t be too financially painful for future retirees.

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