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The 4% Withdrawal Rule

The 4% rule of thumb serves as a guideline to determine a “safe” withdraw rate (SWR) from retirement accounts intended to last a 30-year retirement period. The premise itself is straightforward – you withdrawn 4% of your total retirement portfolio in the first year of retirement. Going forward, the 4% withdrawal rate is adjusted for inflation.

For example, let’s assume you saved $1 million for retirement. Year 1 would mean you withdraw $40,000 ($1,000,000 x 4%). Year 2 would be $40,000 times the annual inflation rate (assume 2%), or $40,000 x 1.02 = $40,800. Year 3 then is $40,800 x 1.02 = $41,616, etc. Now, the inflation rate is used so that you maintain the same purchasing power over our retirement. Inflation being the insidious threat to your comfortable retirement.

The 4% rule was developed by William Bengen, a financial advisor, in 1994 using historical data of various investments classes, but primarily stocks and bonds. His original simulations were based on 50% stock/50% bond asset allocation. Using the 50/50 asset allocation, the 4% withdrawal rate resulted in all simulations lasting 30 years and most lasted 50 years. Thus, the development of the 4% rule, though not coined by Bengen.

More recent analysis, preformed by Michael Kitces, suggests the 4% safe withdrawal rate is conversative. His analysis suggests that those with a 60/40 asset allocation would result in 2/3 (67%) of retirees having an investment balance of more than 2x their starting investment balance after 30-years. Kitces’ research does suggest a higher “safe withdrawal rate” of possibly 5% to 6%.

Now, is a $1,000,000 retirement portfolio really reasonable? For another blog post…

Stay safe and let me know if you have any questions.

Sergio

(714) 987-2261

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