There are certain milestones and benchmarks financial planners use to double check that clients’ are on track and able to live a promising retirement. One of those generally widely accepted rules of thumb is the 4% withdrawal rate, which basically states that retirees can maintain (possibly even grow) their asset base over a 30 year period, if they are able to live on 4% of the starting asset base each year in retirement. One would then adjust for inflation and re-calculate the new 4% figure in year 2, rinse and repeat.  

As such, the rule says a hypothetical $1,000,000 asset base at the start of retirement for a 65 year old, should be able to survive various markets, years of inflation, and provide an income stream which starts at the base of $40,000 in year one, then adjusting each year going forward at the same 4% rate thru that person’s retirement. The idea of this rule of thumb is a simple answer to the back of a napkin question of “how much can I spend every year in retirement?” 

There have been countless studies done on this going back to 1994 when the rule was penned by William Bengen. We use this rule of thumb in our practice and based on the studies I largely agree with the premise. With that being said, there are times and issues that need to be considered which put this general rule under scrutiny. 

In my opinion, there are two areas that we have to be largely concerned with when discussing this 4% rule of thumb. Today’s low interest rate environment and sequence of return risk. 

Today’s low interest rates is one area of concern when running projections. If you go back to the 90’s and early 2000’s many advisors fell in love with running a balanced (60% equity, 40% fixed income) approach to building portfolios. The 40% fixed income (bonds) were deemed to be safer, but also yielded between 4-7% relatively safely at that time. This helped the performance of this 40% slice and in today’s very low 0%-2% interest being earned environment this would hold back the success of that same 40% slice. Hence the dilemma of the strategic buy and hold 60% equity/40% fixed income portfolio in regards to long term retirement success. The original 4% rule was created in a higher interest rate world and the probability of successes were far more favorable when compared to today’s near zero yield. 

A recent study done and article, “Be Afraid, Very Afraid, of Retirement in the 2020’s” by John H. Robinson shows only a 71% success factor for the traditional 60/40 model. These same projections were coming in closer to 98% successful back in the 90’s due to the higher interest rates on the bond slice. Another way to look at this is in reverse, which is that there is a 29% chance a client may need to alter or live on less in their plan. Years ago, there was only a 2% chance that one would need to pivot and at 2% chance that anything needed to be changed it’s easy to see why this rule became so popular. A 29% chance that we need to pivot is a dramatically different result and something that needs to be monitored for sure when forecasting a 30 year retirement. 

Wade Pfau, from the American College has done a significant amount of research on this rule also. One of his prime concerns, which we agree with, is the actual sequence of returns earned by the specific retiree. A new retiree walking into a recession or poor market will have a harder time maintaining the 4% withdrawal compared to a new retiree experiencing new market highs each of the early years of their retirement. Sequence of returns matter and again is something one needs to track. 

The creator of the rule, William Bengen, has actually updated his own calculations to support a higher withdrawal rate with the addition of a 20% US Small Cap allocation. His new figure is 5%, which would be in direct conflict with other studies. Of course, please note that none of these are apples to apples comparisons as many seem to change the allocation, asset classes used, and number of years. 

Inside of PMG Wealth Management there’s more to just blindly following these rules of thumb. For one, I can say I’m not a big supporter of the 60/40 portfolio today. Everything has a time and place and the markets change all the time. In the 90’s, it worked well and I was a big supporter of that model when the fixed side was earning a decent rate. Today with the low rates being available we’ve had to increase our equity allocations. To be able to take on more equities, as advisors we dig much deeper into our client’s situation…including their budgets, creating emergency funds, tracking income sources, lifestyle needs, wants, goals, risk tolerance, etc. Today’s allocation to support the original 4% rule lines up much better with an 80/20 model then the old 60/40.  

For our pre-retirees and retiree clients we re-calculate these figures every year during reviews to know what our appropriate withdrawal rate is. Sometimes it ends up being 4%, but quite often that number sways higher or lower based on age, number of years anticipated taking withdrawals, annual spending, anticipated inflation, asset levels, taxable vs. non-taxable assets, and the overall allocation of the portfolio. It’s important to monitor each year and I suppose the main message of this article is to not blindly accept a popular rule of thumb as gospel and yes, we can help you get a better handle of the question “how much can I spend each year in retirement?”

Anyone needing help calculating “your number” or running retirement projections please let us know. 

Phil Guerrero, CFP®
President & Wealth Advisor
PMG Wealth Management

Disclaimers and Sources:
“Be Afraid, Very Afraid, of Retiring in the 2020’s”…by John H. Robinson, 6/7/21
“Wade Pfau: The 4% Rule Is No Longer Safe”. Podcast by Christine Benz, Jeffrey Ptak, Morningstar, April 29, 2020. 
“Choosing the Highest Safe Withdrawal Rate at Retirement”. Financial Advisor Magazine, William P. Bengen, October, 2020. 
Kitces, M. & Pfau, W. “Reducing Retirement Risk with a Rising Equity Glide Path” Journal of Financial Planning. Vol. 1. P. 38. 

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