A Morningstar article
"Unpacking the 4% Rule for Retirement-Portfolio Withdrawals"
by Christine Benz
discusses the 4% rule (initially spend 4% of portfolio value, and
increase withdrawals with inflation thereafter), which I think is
risky, because it ignores changes in portfolio value. At the least, I
think this rule should be supplemented with a rule that caps current
annual withdrawals as a portion of portfolio value, say 6%. If the
spending dictated by the 4% rule exceeds 6% of CURRENT portfolio
value, the retiree spends only the 6%. Following the 4% rule blindly
can lead to a retiree running out of money if his portfolio does
Nice article. The Trinity study is getting old, and I'd like to see more
analysis, say, how this plan fared through the '00s.
I'd suggest there are a number of variations, one you show, the 6% cap.
Other is that in down years, the withdrawal doesn't get an inflation
My own plan is the budget for retirement not include social security at
all. So, while we're spending 4%, we're not yet taking SS benefits and
when they kick in, our spending doesn't change, but our true
'withdrawals' would be about 2.8-3%.
Last - I am not a fan of annuities, except for the immediate kind. A
$200,000 payment will get us $12,000/yr. This would otherwise be the
withdrawal off of $300K. An intelligent look at one's wealth, and desire
to leave an inheritance, compared to the straight 4% rule might point to
a mix where, on $1.5M which would offer a $60K/ yr return, one might buy
$500K in the immediate annuity, returning $30K. This leaves the
remaining $1M with a safer 3% withdrawal. Just thinking out loud here.
(The annuity does not inflate, by the way, but one is also less active
at 75 than 65, in general)
to see what lifetime risks are. With interest rates low, immediate
annuities don't have much of a payout until age 80. If a person has
severe or chronic health problems it doesn't make sense to buy an
immediate annuity because death might come earlier than average.
Agree, 100%. The purchase is a shift of risk, at a cost. The 4%
withdrawal carries risk both from the market and longevity, the IA, that
you'll die, although I quoted a 6% that was a joint number, obviously,
I'd not want to take "our" money and buy an IA on just my life.
Such a person should consider getting a Medically Underwritten (?Rated
Age?) Immediate Annuity. Someone with such problems might actually
have a *greater* need for the income stream than a healthy person
A person with a serious medical condition may qualify for an annuity
which pays them a greater
than normal income. This occurs when an insurance company determines
that the person?s actuarial
age is older than their chronological age. The level of income
calculated based on a so-called ?rated
age? is usually greater because the insurance company expects the
duration of the income stream to
be shorter, i.e., the company expects to make fewer payments.
I cooked up a quick spreadsheet modeling the drawdown from a $1M
portfolio invested entirely in VFINX. It survives a 7% annual
withdrawal, adjusted for inflation, with no loss of real value over
the past 21 years (21 years being the life expectancy of a 65-year-
old). Here's a link to the Google spreadsheet:
The CPI values are from Robert Shiller and the VFINX data is from
Yahoo (adjusted for dividends, of course). I suppose I could have
used Prof. Shiller's S&P 500 data and adjusted for dividends, myself,
but I was lazy. Plus it's nice to have the fund expenses baked in to
If anyone would like to see variations on this, just let me know.
Nice. Note, however, the 90's S&P returned a CAGR of 17.59%. So I'm not
too surprised that it survived the '00s, since it grew enough so the
withdrawals in the '00s start at near 3%.
A deeper analysis would offer start dates moving forward, year by year,
right to the 'lost decade.'
Start 2000 at even a 4% withdrawal and where would we be now?
tnx for the info to consider....
We are just now starting to think about the whole retirement planning,
and mostly how to draw down from various sources.
It's not so much having to create the wealth,
but on the flip side - how and where to draw the funds.
We have a pretty healthy portfolio of stocks.. and some bonds.
But haven't thought about how to sell those for cash.
The main support will come from wife's teacher pension,
and I have a little SS - but not counting on it.
BTW - teachers that get a state funded pension
in most cases LOSE their SS benefits from any payments prior to becoming a
Actually it's like a threshold thing, but if you had some SS prior to
and then taught for a long time - the teacher retirement will overshadow the
and you get nothing from SS...
I wish Morningstar or someone would do a survey to see if they can find
any 1990s-early 2000s era retiree who actually followed one of these
rules as a withdrawal strategy. Meaning, in year one multiplied their
account value by 4%, 4.2367%, whatever, and took that out, and increased
the amount by CPI every year. I seriously doubt that person exists!
I've always thought of it as a construct for discussing the risk of
running down savings during retirement. A precisely defined percentage
may be of interest to an institution (e.g. insurance company, pension)
that makes contractual promises regarding lifetime income. But those
institutions aren't necessarily motivated to maximize the benefit, there
may be padding for risk insurance and profit. And they have alternatives
like offloading the risk of drops (via derivatives - like the ones sold
to Berkshire Hathaway), or for pensions, increasing contributions when
investments don't go well.
In practice, for individuals, I think it's the rare area where
behavioral issues work in your favor...the tendency seems to be cutting
back on spending when investments drop in value, exactly the opposite of
the assumption in the 4% simulations - that have you blindly increasing
spending for CPI every year.
Cheap "withdrawal strategy": follow one of the IRA minimum distribution
tables - which is a steadily-increasing percentage of last year's
account value. At age 65, the single life table says 21.0 is your
divisor, 1/21 = 4.8%. All roads lead to Rome?
Tad Borek writes:
Of course, there's a huge difference between the single-life
table and the uniform (which basically assumes joint life
for a couple where they are both of similar age) table.
At age 70, the single-life table gives a life expectancy of 17
years, meaning about 5.9%, while the uniform table gives 27.4 years,
And, of course, the biggest wrinkle of all, if you use
the single-life table and are 111 years old or older,
the life expectancy is defined to be 1 year, so as soon
as you are 111, you spend the entire thing down in that
one year and will be broke for all the years which follow...
In reality, like Tad, I use these kinds of tools as
starting points for discussions, not etched-in-stone
plans. Planning and managing distributions in retirement
is a process, not a one-shot deal. These guidelines are
probably more useful long before retirement for helping
to estimate targeted savings goals. If I have, say, a
couple who are in their 30s or 40s, with retirement
20-30 years out, it's impossible to know exactly how
much they are going to need to save, but the 4% rule
is a great starting point - it implies that your savings
needs to be 25x the amount you plan on spending annually
out of that savings.
For a 65 year old couple, perhaps one or both of whom
are already retired, the 4% rule isn't enough - it's
still just a starting point. More realistically, we
need to assess their resources, their spending patterns
(especially things like if/when their house will be
paid off leading to huge drops in monthly cash-flow
needs), and especially importantly - ideas for plan
B and plan C - what do you do if your spending is
higher (or investment returns are lower) than you
expected. When a couple is 60 or 65, I really look
at their retirement more like endowment investing
rather than a spending-down plan. Their time horizon
needs to be 30 years - the odds are substantial that
a couple who are both in that age range will have at
least one of them live 30+ years. That "endowment"
idea, of course, like a real endowment, needs to be
carefully reviewed regularly. Real endowments don't
use the 4% rule (which doesn't adjust payouts when
One widely used endowment rule was to tie spending
to 5% of the three-year rolling average of total
endowment market value. The three-year average
smoothed it out so that spending wouldn't drop quite
so much after a bad market year, and tying it to
asset value rather than fixing a dollar value and
adjusting with inflation (4% rule) meant that if
the assets did underperform, spending would have
to be throttled. Perhaps I'll run some historical
numbers for the 5%/3yr rule against some traditional
portfolios (ie. 60/40 SP500/LehAgg). Note that in
an ongoing down/flat market, this 5%/3yr rule does,
in fact, lead to asset depletion and lowered spending.
There are a lot of other endowment rules out there
and in use, with varying degrees of complexity in
the formulae, and varying degrees of adherence to
stability in spending versus linking spending to
market returns. And I think anyone doing this kind
of planning can learn a lot from them - knowing full
well that retirement is *not* the same thing as an
endowment and that you do have to have plan B and
plan C available. Endowments (ie. Universities)
may have a lot more leeway to either cut spending
or ask for more donations than retirees have...
David S. Meyers, CFP(R)
(see the "Percentage of Portfolio With Ceiling and Floor" section)
discusses imposing a cap and floor of the proportion of the portfolio
spent, as I suggested above. I agree with Tad's comment that these
percentage caps and floors should increase with age, to account for
decreased life expectancy.