Revisiting the 4% Safe Withdrawal Rate

Is the 4% rule in retirement reliable?

There’s a general rule of thumb that says if you retire you can safely withdrawal up to 4% of your nest egg every year without it running out before you kick the bucket. Financial advisor Bill Bengen, now retired, came up with this guideline after testing a variety of withdrawal rates using historical rates of returns for stocks and bonds. He published a study in 1994 about how 4% was the highest sustainable withdrawal rate retirees could use.

But 1994 was over two decade ago. How does the 4% rule hold up today, after the great recession? Bill recently did some further research into the topic and according to him, the 4% rule still holds true today. 🙂 In fact, he is even confident that retirees can safely withdrawal not just 4%, but actually 4.5% if they are okay with their nest eggs lasting for only 30 years.

In a Q&A session on Reddit last week, Bill explained the methodology, details, and implications of his findings. He says that 4.5% is the “percentage you could “safely” withdraw from a tax-advantaged portfolio (such as an IRA, 401(k), RRSP, or TFSA) the first year of retirement, with the expectation you would live for 30 years in retirement. After the first year, you “throw away the 4.5% rule and just increase the dollar amount of your withdrawals each year by the prior year’s inflation rate.”

For example, if you had $1,000,000 in a retirement account, you would withdraw $45,000 in the first year of your retirement. Let’s say inflation during this year was 2%. This means in the second year you may withdrawal $45,900. Overall, Bill recommends a 50% equities/50% bonds mixture at the beginning of one’s retirement.

Other factors to consider

As for how recessions, interest rates, and government policies affect the safe withdrawal rate over time, Bill reassures us that these factors have little bearing on the safe withdrawal rate. There are only 2 major factors that count.

1. Encountering a major bear market early in retirement.
2. Encountering high inflation during retirement.

Bill explains that both these factors “drive the safe withdrawal rate down.” His research is based on data going back to 1926. He tests the withdrawal rates for retirement dates beginning on the first day of each quarter, beginning with January 1, 1926. The average safe withdrawal rate for all those 300+ hypothetical retirees is, “believe it or not, 7%! However, if you experience a major bear market early in retirement, as in 1937 or 2000, that drops to 5.25%. Add in heavy inflation, as occurred in the 1970’s, and it takes you down to 4.5%.”

A 5% safe withdrawal rate might be a little too high. But so far, Bill has not seen any indication that the 4.5% rule will be violated. Both the 2000 and 2007 retirees, who experienced big bear markets early in retirement, appear to be doing okay with 4.5%.” 🙂

But if we were to encounter a decade or more of abnormally high inflation, then things could change. Bill says that inflation is the retiree’s worst enemy. “As your time horizon increases beyond 30 years, as you might expect, the safe withdrawal rate decreases.” For example – for 35 years of retirement, the rate goes down to 4.3%. For 40 years, 4.2%. And for 45 years, it’s only 4.1%. Bill thinks that if you plan to live forever, 4% should do it.

“My 4.5% rule represents the “worst case” experience of a retiree who retired in late 1968 or early 1969. This retiree experienced two early bear markets and very high inflation for decades.” ~Bill Bengen

So there we have it. The 4% rule is still valid. 🙂 Yay. Just be careful about inflation. Make sure to hold real estate or other hard assets to combat inflationary pressures over the decades to come.

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