Why you may want to ignore the 4% rule for retirement withdrawals

The creator of the “4% rule” for safe retirement portfolio withdrawals doesn’t even believe in 4% anymore. That’s good news, as the actual safer percentage appears to be higher.

So you’ve spent decades of your life building up a sizable retirement account, mostly likely in one or more 401(k)s or IRAs.

And you’ve determined that you’re at the point where you want to move from primarily working for your money to having your money primarily work for you. (That’s my definition of what we usually call “retirement”.)

Assuming you’re at the point where there aren’t any penalties for withdrawals, you may be asking the following question:

How much money can you reasonably take out of your retirement accounts so that you don’t run out of money?

The conventional wisdom has been in place for some time. But even the author of that conventional wisdom is changing his mind.

Conventional wisdom

The conventional wisdom is that you should withdraw no more than 4% of your retirement balance each year. The reason for this is so that you never run the risk of taking out so much money that you start to draw down your principal and eventually run out of money.

In short, so you “don’t outlive your savings”.

This has become known as the “4% rule”, and it’s treated more or less as sancrosact. It just is.

In fact, it’s so ingrained in my psyche that I never actually looked into where it came from.

Enter Bill Bengen

It turns out that it’s not some fundamental law of nature. It was formulated by Bill Bengen, a financial adviser in California, and published in an article in the Journal of Financial Planning in 1994.

Bill Bengen, 1994 (Source)

In it, he states, that average returns don’t take into account the wide swings in the market, such as in the 1973-1974 recession.

And unfortunately, if you lose, say, 10% one year, and then gain 10% back the next year, you’re not back at 100%. You actually have to make back more to break even. The wider the swing, the more you have to make back.


it pays to look not just at averages, but at what actually has happened, year-by-year, to investment returns and inflation in the past.

And that’s what he did. He ran through some hypothetical portfolios through the biggest financial events of the past century or so, and then determined what he called “portfolio longevity”, meaning “how long the portfolio will last before all of its investments have been exhausted by withdrawals.”

(Granted, this violates that whole “past performance is no guarantee of future results” tenet, but let’s face it, what else do we have to go on?)

What is safe?

He found that a 3% withdrawal was totally safe, but “unacceptable” for most clients, since that wouldn’t amount to much in most portfolios. (For a $1 million portfolio, that would be $30,000 in the first year.)

He also found that a 4% withdrawal “should be safe”. The worst case scenario had the portfolio exhausted in 33 years, but most cases, it lasted much longer.

From the original article. Emphasis mine, obvs.

But once the percentage got higher than 4%, in some cases the portfolio was exhausted in a shorter time than most people expect to be in retirement.

Because of this, he stated:

I counsel my clients to withdraw at no more than a four-percent rate during the early years of retirement, especially if they retire early (age 60 or younger).

And bam! A financial law of nature was born. Call it the “money quote”. (Sorry.)

It’s not so simple

I should point out a few things:

  • The 4% target wasn’t guaranteeing a perpetual portfolio in all cases. It was just modeled out to be around for at least three decades.
  • All of these projections have to take into account inflation. 4% in a 2% inflation world is very different from 4% in a 6% inflation world.
  • The advice is based on a worst-case scenario of the last century or so. In many cases, withdrawals of 5%, 6%, or even higher had plenty of portfolio longevity to last you well beyond your retirement years, though this was dependent on the luck of when the recessions happened.
  • Longevity was dependent on the ratio of stocks to bonds in the portfolio. Given a more aggressive portfolio (75% stocks instead of 50% stocks), your chances of surviving downturns appeared to increase in many cases. In short, being more risk-tolerant—even in retirement—may turn out to be a safer bet for your portfolio longevity! Let that sink in.

Bill updates his model

But it turns out that even the author of this conventional wisdom is having second thoughts.

In an interview with Marketplace, he talked about how even with all that nuance, you’re probably okay with withdrawing more than 4%.

Because the estimates were for the worst-case scenario since the 1920’s:

[A]t other points in history—when inflation was low, and stocks and bonds were cheap—a new retiree could have withdrawn much more and done OK. Historically, he says, the average safe withdrawal rate has turned out to be about 7% and at points it has reached as high as 13%.

And in fact, he has even updated his most conservative estimate to 4.5%, not 4%. And he himself uses 5%.

More questions, more thumbs

For most people, the percentage isn’t even the most urgent issue you face: it’s the amount of money you’ve put away.

Now, this rule of thumb leaves many questions unanswered, regardless of the interest rate you choose.

A 5% withdrawal from a Roth IRA ends up being more money in your pocket than a 5% withdrawal from a 401(k), because of the tax liabilities.

If you take out 5% out from a pre-tax account with $1 million in it, you get $50,000, but after income taxes, you may be left with only around $35,000. In contrast, 5% out of an account where taxes have already been paid (such as a Roth IRA) would give you precisely $50,000.

That’s one of the more under-appreciated benefits of a Roth IRA: certainty. You know exactly what you have.

To get the same amount in a pre-tax account, you’d need to take out more like 7%.

So what do you do in this situation? How do you know “which 5%” to take?

And that’s where I take the easy route out and say “it depends”.

Because a rule of thumb is only the full picture if you are nothing but thumbs.

The real amount that you can withdraw each year depends on many different factors, including your tolerance for risk, your age, your portfolio, and your specific plans.

The percentage rule, whether it’s 4%, 5%, 7%, whatever, is just there to give you a very rough estimate of what your income could be in a sustainable, long-term situation.

For most people, the percentage isn’t even the most urgent issue you face: it’s the amount of money you have put away. After all, the more money you’re working with, the less percentage you need to have the same amount of money, or the more you could take out and still be sustainable.

So I’d focus on getting that number up to what you need, regardless of the percentage.

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