4% rule

Michael Kitces, blogger and head of planning strategy at Buckingham Wealth Strategies, recently interviewed Bill Bengen, the “father” of the 4% rule, the “safe” withdrawal rate for retirement savings.

In the discussion, the retired advisor said he actually used 4.5% instead for his clients. In fact, with inflation as low as it is today, he told Kitces the safe withdrawal rate may be closer to 5%.

In the podcast, Bengen stated that at the time of his research — the late 1990s — there were mainly two asset classes: large-cap stocks and intermediate government bonds. Today there are many more investment opportunities, he said.

He told Kitces his thoughts about today: “Right now, I would not be recommending 4.5% to clients as a starting point. Depending upon the inflation level and the level of the market, I might be up to 13%, which historically, there were periods of time when you could take withdrawals that high.

“It’s not a great time to be taking high withdrawals now with the market so expensive, but it’s not awful either because inflation is very low. I think somewhere in 4.75%, 5% is probably going to be OK. We won’t know for 30 years, so I can safely say that in an interview.”

Inside the Numbers

In an article on Morningstar, John Rekenthaler, Morningstar vice president of research, analyzed how a 4% real withdrawal rate as a hard-and-fast rule might fare when considering a portfolio return of 4.1% and inflation rate of 2%.

Beginning with a $1 million portfolio, profit would be underwater already by Year 3. (Year 1 profit $41,000, withdrawal $40,000.)

In Year 2, the portfolio would start with $1,001,000, but profit would be only $241, after pulling out $40,800.

Continue to Year 3 where the red starts showing. The portfolio starts out at $1,001,241, but with appreciation of $41,051 and withdrawal of $41,616, it loses $565. In year 4 is when the original portfolio amount falls into the red, to $999,255, and so on. Rekenthaler notes that in year 38 the portfolio hits zero.

We asked Rekenthaler about a 38-year period of retirement, and he replied that “Unless somebody retires very early, 38 years will suffice. I gave that information for three reasons. One, to follow up on the point that although the portfolio initially increases, it eventually goes to zero.

“Two, to contrast with the much longer time period for when the portfolio has higher returns.

“And three, to give a sense of [where] things stand, should the forecast be over-optimistic. Thirty-eight years seems fine, but if market returns are significantly worse than expected, that number could shrink dramatically, to maybe 20 or 25 years, which would then become a practical concern.”

He adds in the article that the “canary in the coal mine” for the calculations is that the 4% withdrawal rate actually climbs as the portfolio drops in amount. So by year 5, that withdrawal rate is up to 4.33%.

He concludes that the break-even point for portfolios and real withdrawal rates is the sum of the withdrawal and the inflation rates. In this case it would be 6%. As he notes, Bengen understood “when the numbers can serve as guides and when they should only be guidelines.”

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