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Retirement

The 4% Withdrawal Rate is a Lie, Use This Instead 

4% safe withdrawal rate

For many years people relied on the concept of the 4% withdrawal rate to plan for retirement. However, many experts now say that this method is outdated. If you’re planning on using it for your own future, think again. There are better options for a safe withdrawal rate that you need to consider instead.

What Is The 4% Withdrawal Rate?

The 4% withdrawal rate is a percentage that many people use in retirement planning. The idea is that you should plan to withdraw approximately 4% of your retirement account each year once you retire. Obviously, the intention is to allow you to have a steady amount of income to meet your needs in retirement. At 4%, you are supposed to have what you need and yet not max out your retirement savings during your lifetime. While it’s a popular retirement planning method, many experts now agree that this is not a safe withdrawal rate.

The History of the 4% Withdrawal Rate

Kitces has a great interview with Bill Bengen, the so-called father of the 4% withdrawal rate. Bengen was a financial planner who was trying to solve problems in retirement planning in the 1990’s. He used historical data on finances over several decades to determine a safe withdrawal rate for retirees. His plan became the standard rule of thumb for other financial planners and their clients.

However, even in the 1990s, he didn’t actually use the 4% withdrawal rate. He recommended a 4.5% withdrawal rate for his clients instead. And in the Kitces interview, he says that in today’s world, a 5% withdrawal rate is probably a safe withdrawal rate due to low inflation.

There Are a Lot of Factors to Determine a Safe Withdrawal Rate

The 4% withdrawal rate relied on data from the earlier part of the 20th century. People simply aren’t in the same place now as they are then when it comes to money. Moreover, the world’s economy is different. When trying to assess a safe withdrawal rate, you need to take into account a wide variety of individual and economic factors.

As Bergen suggests over on Kitces, low inflation allows for a higher withdrawal rate. Money Sense notes that low interest rates are one factor. Rising expectancies, increasing investment rates, and long life expectancies pose additional considerations. Think about it: are you planning to retire at 65 and likely to live to 95? That may greatly affect your retirement planning in comparison with someone who wants to retire earlier or later or who has a family history likely to end in a premature death.

And you have to consider your own feelings about retirement and the risks you’re willing to take with your money. Whereas Bergen says that 5% is now a safe withdrawal rate, Money Sense errs on the side of caution and uses a 3% withdrawal rate to plan for a long period of retirement. And Financial Samurai is even more conservative, suggesting 1% or less withdrawal at least in the early years of retirement.

Financial Samurai’s Alternative Safe Withdrawal Rate

Financial Samurai suggests this equation for your retirement planning: A safe withdrawal rate is a 10-year bond yield x 80. The article explains in-depth how this would mean that a $1 million retirement investment today would result in $17,000 of pre-tax income at the current bond yield of 1.7%.

The reason that they suggest this method is:

  • You don’t have to touch your principal. Living off your interest in retirement is ideal to give you a cushion in case you need it.
  • It’s a conservative option that allows you to plan not only for your future but for the generations beyond yours. In contrast, the 4% withdrawal rate uses up all of the money you have.

Financial Samurai has also provided a Safe Withdrawal Rate chart that ranges from 0.08% to 5.6% depending on the ten year bond yield.

An Alternative Retirement Plan

Financial Samurai also suggest another calculation. That option is to try to amass 20x your gross income before retirement. This allows you to gather what you need in order to survive well in retirement. Plus, it’s an easy calculation. However, it’s a bit simplistic.

Again, whenever you do retirement planning, you really need to think about a range of different factors. Life expectancy is a big one as is the quality of life you want to have when you retire. Moreover, you have to ask yourself if you want to spend out your retirement in your lifetime or leave something for the next generation. None of these are easy decisions.

Moreover, as Financial Samurai points out, you want to think about what retirement income might look like. Have you invested in risky, but potentially high-yielding investments? Are you able to use passive income or part-time work to supplement retirement income? Again, these are all important factors that might change the decisions you make about a safe withdrawal rate for you unique situation.

Working With a Financial Planner for Retirement Planning

Because there are so many different factors to take into consideration, you might want to consider working with a financial planner to figure out your financial retirement plan. After all the “father of the 4% withdrawal rate” was a financial planner. He used what he knew to help his clients. Like him, your financial planner will use the current rules of thumb as a starting point to assist you in figuring out what some good safe withdrawal rates might be. However, they will then take into consideration all of those other personal factors that might change this rate for you in either direction.

You don’t want to follow “rules” blindly when it comes to finances. As we’ve seen since the time that the 4% withdrawal rate was the norm, things change. Even if you stay up to date with the current recommended rates, your own personal situation might change. Developing a rapport with a financial planner who truly understands your needs and wants can be a good way to implement the right rules while circumventing those that simply don’t make sense for you.

What is your retirement plan? What questions do you have about planning for retirement?

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