Is 4% Withdrawal Rate in Retirement too High

Investment News (IN) had a write up that posited a 4% withdrawal rate in retirement is now too high.


By Roger Nusbaum

The basic idea is that the 4% rule is built on interest rates from the bond market that no longer exist. When William Bengen came up with 4% in 1994, the US Ten Year Treasury Note had a yields in the sevens as in a little more than 7%. Today it yields 0.71%. Even if the equity market was only going up 6% annualized (below normal), it’d be a good bet that 4% would be sustainable with safe bond (NYSEARCA:BND) yields in the high single digits.

Wade Pfau (thought leader) was cited in the article, his work leads him to think that a 2.29% withdrawal rate is the new 4% and David Blanchett from Morningstar chips in with a 3% opinion. The actual 4% rule says you start at 4% and increase it by the rate of inflation every year. This has always seemed impractical to me, who crunches the numbers and sees “oh, my expenses went up 0.3%.” My experience is that clients who are taking money out usually take a fixed dollar amount that is reasonable, they stick with it for some period of time, then something changes and they will either take more or less depending on that change. If three years into your retirement, you pay off your mortgage then maybe you’d reduce what you take. And of course along the way people have occasional big one off expenses and they take money out to cover those expenses.

As opposed to being overly dependent on retirement account withdrawals, a more robust approach would be to have the portfolio be one of a couple income streams. Other income streams could include loving what you do so much that you don’t retire, some sort of post retirement, part time career, a monetized hobby, real estate income and no doubt there are others. The first three there are ideas we’ve been looking at for years here. Those types of opportunities are more likely to be successful by starting early, long before retirement. Betting you’ll get lucky on your first day of retirement finding something that replaces half your income with only a quarter of the time spent is a bad bet. It’s possible but it’s not probable.

Another way to be less dependent on a portfolio is to cut expenses way back when you retire. This is less about lifestyle choices and more about careful planning. A couple planning to retire at 65 could reasonably get their mortgage paid off by age 60, buy a couple of Toyotas that could be paid off in five years to coincide with retirement and easily drive those cars until at least age 80 if properly maintained. What are your expenses now? What are they with no mortgage and no car payments. We’re walking that walk with a 2003 4runner and a 2006 Tundra.

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I’ve been candid about our preferences which are that I don’t retire, we would delay Social Security as long as possible (it looks like we max it out if I take it around 69 and my wife at 65) and keep our rental property. Our portfolio would be for emergencies and travel if going places ever becomes a thing again. Plan B or C would involve greater reliance on the portfolio.

Morgan Housel had a powerful blog post that I would encourage you to read. Recapping the post wouldn’t do it justice so I will just grab one line; tail-end events are all that matter. The short definition of tail risk is when something extreme happens and the consequences are severe. A pandemic is outside the realm of normal threats. The Great Financial Crisis was outside the realm of normal threats. And while some tail risks are beyond our ability to mitigate some are not. You might not be able to avoid getting Covid 19 but we know that people who have metabolic maladies like T2D or weight issues are more vulnerable to the disease. Mitigation can possibly come from proper diet and exercise ahead of time. Most of us can’t guess about a pandemic coming but there is no one who doesn’t know that diet and exercise are important for good health even if they aren’t sure what it means to eat well or how to exercise effectively. They can learn and improve their odds against Covid 19 or future events where health is such an obvious difference maker.

Similarly with personal finances; addressing sequence of return risk with an adequate cash cushion or specific defensive strategy can mitigate tail events like we had in March or 12 years ago in the GFC. These are both examples of resiliency without predicting anything. As many people have said, most retirement plans have goals related to dollars and sustainability as opposed to beating a benchmark by X number of basis points. Manage to your desired outcome with a strategy that covers your bases let’s you avoid panic.