The four-percent rule for safe withdrawals during retirement: Theory versus reality

Last week, I wrote about the problem with retirement spending: How much should you spend during retirement? If you spend too much, you run the risk of depleting your savings. But if you spend too little, you're sacrificing the opportunity to make the most of your money, to “drink life to the lees”.

One of the guiding principles in retirement planning is that there's a “safe withdrawal rate”, a pace at which you can access your investments so that your nest egg will last for thirty years (or longer).

For simplicity's sake, a lot of folks talk about the “four-percent rule”: Generally speaking, it's safe to withdraw 4% from your investment portfolio every year without risk of running out of money. (This “rule” manifests itself here at Get Rich Slowly when I say that you've reached Financial Independence once you've saved 25x your annual spending — 33x your annual spending if you want to be cautious.)

Today, I want to take a closer look at the four-percent rule for safe withdrawals — then explore why the theory behind it doesn't always mesh well with the reality of our daily lives.

The original four-percent rule article

The Four-Percent Rule Defined

Last August, William Bengen (who first proposed the 4% rule in a 1994 article), participated in an “ask me anything” discussion at the financial independence subreddit.

Here's the top question and answer from that thread (with additional formatting for readability):

Question
Is the 4% rule still relevant in today's economy? What safe withdrawal rate would you recommend for someone planning for longer than 30 years of retirement?

Answer
The “4% rule” is actually the “4.5% rule” — I modified it some years ago on the basis of new research.

The 4.5% is the percentage you could “safely” withdraw from a tax-advantaged portfolio (like an IRA, Roth IRA, or 401(k)) the first year of retirement, with the expectation you would live for 30 years in retirement. After the first year, you “throw away” the 4.5% rule and just increase the dollar amount of your withdrawals each year by the prior year's inflation rate. Example: $100,000 in an IRA at retirement. First year withdrawal $4,500. Inflation first year is 10%, so second-year withdrawal would be $4,950.

Now, on to your specific question. I find that the state of the “economy” had little bearing on safe withdrawal rates. Two things count:

  • If you encounter a major bear market early in retirement, and/or
  • If you experience high inflation during retirement.

Both factors drive the safe withdrawal rate down.

My research is based on data about investments and inflation going back to 1926. I test the withdrawal rates for retirement dates beginning on the first day of each quarter, beginning with January 1, 1926. The average safe withdrawal rate for all those 200+ retirees is, believe it or not, 7%!

However, if you experience a major bear market early in retirement, as in 1937 or 2000, that drops to 5.25%. Add in heavy inflation, as occurred in the 1970's, and it takes you down to 4.5%. So far, I have not seen any indication that the 4.5% rule will be violated. Both the 2000 and 2007 retirees, who experienced big bear markets early in retirement, appear to be doing OK with 4.5%. However, if we were to encounter a decade or more of high inflation, that might change things.

In my opinion, inflation is the retiree's worst enemy. As your “time horizon” increases beyond 30 years, as you might expect, the safe withdrawal rate decreases. For example for 35 years, I calculated 4.3%; for 40 years, 4.2%; and for 45 years, 4.1%. I have a chart listing all these in a book I wrote in 2006

If you plan to live forever, 4% should do it.

That's some helpful information, and it comes directly from a man who has been researching this subject for 25 years. Obviously, it's no guarantee that a four-percent withdrawal rate will hold up in the future, but it's enough for me to continue suggesting that you're financially independent once your savings reaches 25 times your annual spending.

But here's the catch — and the reason I'm writing this article: From my experience, spending in early retirement is not a level thing. It fluctuates from year to year. Sometimes it fluctuates wildly.

The Fundamental Problem with the Four-Percent Rule

Last October at Our Next Life, Tanja wrote that the fundamental problem with the 4% rule for early retirement isn't the 4% rule. “The fundamental problem with any ‘safe' withdrawal rate is the underlying assumption of level spending over time,” she said.

And you don’t have to be planning for dirtbag years followed by larger-living years, as we are, to be looking ahead to increasing costs in the future. You could be the most disciplined budgeter of all time and still need to plan for your spending to change over time.

The problem, Tanja says, is that many costs — especially costs for large expenses — can outpace inflation. Health care costs, for example, have been skyrocketing for years. So has the cost of higher education. Housing costs too have been increasing faster than inflation (and their historical average).

Meanwhile, Social Security and private pensions have not kept pace with inflation. (That's one reason that, like many of you, I don't even consider Social Security when calculating my retirement figures. Yes, I look at my projected benefits now and then. But to me, any future SS payments will be a bonus, not part of my actual calculations.)

For Tanja and Mark at Our Next Life, the solution to this “fundamental problem” is to take a two-phase approach to early retirement.

  • The first two decades will be their “dirtbag years”. During this time, they'll have to rely on money from regular, taxable investment accounts. In order to maximize the chances of their money lasting, they plan to live lean. They'll still enjoy life, but they'll do so on a reduced budget.
  • Gradually, they'll introduce rental income. Then, when they turn 60, they'll have access to tax-advantaged retirement accounts. (Plus, of course, they should still have some money in taxable accounts.) At this time, they intend to increase their spending.

I like this approach because it builds in the expectation that spending is going to increase as they age — whether they like it or not. Some of this increase will come because they'll get tired of living with less, but some of it will also come from external forces — from inflation, from the costs of health care. I think they're being smart.

My Experience with Early Retirement Spending

From my personal experience, spending during retirement — especially early retirement — hasn't been level. There may be some baseline that you tend toward (like reverting to the mean, basically), but some years you spend a lot, and some years you spend a little.

I look at it as being similar to the stock market. Over the long run, stocks offer a 6.8% real return. That’s their average. But average is not normal. Some years, stocks drop 20%. Other years they’re up 40%. But they’re very rarely at or near 6.8%.

The same concept applies to spending in early retirement.

I achieved Financial Independence in 2009 when I sold Get Rich Slowly. (My income from this site was such that I would have achieved FI in 2011 without the sale. The sale accelerated the process.) Since then, both my spending and income have fluctuated wildly each year.

In 2010, for instance, I earned six figures (yes, despite having sold the blog) but spent very little. I had no mortgage. Kris and I grew a lot of our own food. I worked from home. I hadn't yet succumbed to the travel bug.

My high income continued for a few years, then dropped off sharply. I believe this is why I was audited by the IRS (although you never can be truly certain). For the past few years, I've been lucky to earn $20,000 in a year — although I'm hopeful that I'll earn more now that I've repurchased Get Rich Slowly.

Meanwhile, my spending has been, well, variable.

During 2012, I didn't spend a lot. When Kris and I got divorced, I moved into a cheap apartment and didn't go out much. When I bought my condo in 2013, however, there were plenty of unplanned expenses. While Kim and I were on the road in the RV for fifteen months, our spending was relatively low. But this year? This year, I've spent over $100,000 — and it's only June!

Fortunately, most of this spending is non-consumer in nature — buying back Get Rich Slowly, remodeling the house — but it's still spending. (And the new hot tub? Well, that's 100% consumer spending!)

My Experience with Early Retirement Withdrawals

That's how I spend my money in early retirement. But how do I actually get the cash to spend? How do I convert it from investment accounts to my checking account? That too tends to vary.

In the early years when I was still earning a lot of money, I didn't need to draw on my investment portfolio. My spending was funded by my income, just like it always had been. (And I had money leftover to add to my stash!)

After my income dried up, I had to change my approach. I had to start tapping my investment accounts. I haven't tried to optimize this process (although I probably should). All I do is cash out large “lump sums” of mutual funds.

Generally speaking, I try to maintain a balance in my checking account of between $10,000 and $20,000. That's my “working capital”, I guess. When my balance drops below $5000, I look at my anticipated expenses for the next 6-12 months, then cash out one mutual fund or another.

I also find that I have to redeem shares when I have large one-time expenses.

  • Buying a condo? Time to sell.
  • Buying an RV? Time to sell.
  • Buying back Get Rich Slowly? Time to sell.

There's a huge downside to this approach. Every time I sell shares from a mutual fund, I take a tax hit. This tax hit is pretty low (the 15% long-term capital gains rate), but it still stings.

Last year, I decided I wanted to try a different approach. Instead of making lump-sum withdrawals, I wanted a steady, reliable source of income. I met with my investment advisor. He and I restructured how my accounts work. Instead of reinvesting interest and dividends, my mutual funds now kick out money into a cash account.

I haven't been using this new approach long enough — and I've continued to have huge expenses — so I'm not sure what the actual implications are. My guess (based on the assumptions my planner and I made) is that my taxable investment account will supply around $15,000 per year. Combined with my income from other sources, this will be enough to cover day-to-day expenses, but I'll still have to cash out lump sums anytime I have a major unexpected expense.

Because I don't want to take the lump-sum approach, one of my medium-term financial goals is to build a balance in some sort of cash (or cash-like) account. I want for this to be my source of operational expenses. If things go well at Get Rich Slowly, my income from this site can serve as the funding source for the new account.

How Do YOU Spend in Retirement?

Over the past decade, I've had zero years of earning and spending that I could consider normal. Zero. Some years I've made a lot of money; some years I've made very little. Some years I haven't spent much; some years I've spent a ton. Honestly, it all seems a little insane.

When I look at my current plan and my current situation, however, it feels like the next few years are moving toward some sort of normalcy. I hope so. As fun and exciting as it's been to enjoy all of these adventures — building and selling a business (then buying it back), traveling the U.S. in an RV, buying and renovating an old home — I crave routine. I also long to have a stable monthly budget.

So, that's how I've handled retirement withdrawals and expenses. I look to the four-percent rule as an ideal, but one that hasn't been applicable to my own life. Not yet, anyhow.

But I'm just one guy — and a strange one at that. I'd love to hear from others.

How do you handle investment withdrawals in retirement? And how do you handle expenses? (Or, if you're not retired yet, what's your plan for these things?) Are your expenses level? Do they fluctuate wildly like mine do? What do you do when you need money? Do you automatically withdraw four percent (or some other amount) every year? Do you use only what your accounts kick off in dividends and interest? Do you pull lump sums? What are things like for you?

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ALICIA
ALICIA
2 years ago

It’s sad that you don’t consider Social Security as part of your retirement income. I do, however, understand why. At your age, you think SS won’t be around or reduced so why depend on it because it is so undependable? I find that very sad. I’ve been retired for 17 years now BUT my husband kept working all that time. Now, we’re both are retired and most of our income comes from passive means. We live on about $25,000 to $33,000 a year. We can do $25K if we embrace austerity but lately, we don’t want to do that anymore.… Read more »

S.G.
S.G.
2 years ago
Reply to  J.D. Roth

I expect it to be tiered much like income tax. The poorest people who need it for survival will see no reduction, but people with other resources will see progressively less. Politically that may mean the end of SS as part of the goal of its supporters is to have as many people with a vested interest in it as possible. A shift to benefits would shift perception of it as more of a welfare program for the poor instead of a retirement program for all. But if benefit reduction leads to its death I expect that to be long… Read more »

Jim H
Jim H
2 years ago
Reply to  S.G.

I’m curious as to how you have dual SS when one of you is 61?

Mike M
Mike M
2 years ago
Reply to  Jim H

Maybe disability ?

Bill N
Bill N
2 years ago
Reply to  J.D. Roth

JD-
My plan calls for late retirement (2 yrs) and then 5 1/2% withdrawals. But I am stacking the deck in my favor, because I will maintain a “cash bucket” apart from our portfolio with 4-5 years’ worth of withdrawals. When the market is up, great! When the market is down, I take Zero from the portfolio and draw one year from the bucket. This insulates me from the down market, and during up markets I can be refilling the bucket.
-Bill N

Brad M
Brad M
2 years ago

My wife and I “retired” at ages 53 and 55 respectively. We haven’t quite saved 25X of our annual spending (we use 25 “best guess” annual estimates for that calculation!). However, we are already funding a lot of our spending with pension income. That income will eventually be fortified by Social Security and then with hefty Minimum Required Distributions (MRDs). My question is, “How should you factor income into the FI calculation?” Should you “net” the income and expenses together when calculating annual spending?

Jack
Jack
2 years ago

As I told you in your previous post I/we blew thru $600K over 12 years in retirement. I am 76 now. Why did we blow through this money? Because we wanted to have a blast in the final chapters of our life. We did! Paid off our old house, traveled extensively, put 4 kids through college. (Expensive colleges/universities). Bought 2 nice new cars toward the end. Why because we KNEW that when our money ran out OUR SocSec would kick in as well as her pension as a teacher. We now live on $5000/mo after taxes and Medicare deductions. Our… Read more »

S.G.
S.G.
2 years ago

So some fun with math for those of you who don’t turn it upside down in your head. Using JD’s numbers means that:

*for every $10,000 in investments, if you retire tomorrow you can safely withdraw about $1 per day for the rest of your life.

*for every $10,000 in investments, if you retire in 10 years you can safely withdraw about $2 per day for the rest of your life.

*for every $10,000 in investments, if you retire in 20 years you can safely withdraw about $4 per day for the rest of your life.

Accidental FIRE
Accidental FIRE
2 years ago

Your comparison of spending amounts changing every year like the stock market, but then averaging a certain amount is a pretty good one. I would like to think that my life would be a little more stable than that, but I don’t know if I would be kidding myself. There’s a part of me that would love to buy an RV and travel around, and if I do that of course I would have one of those massive spending years just for the RV alone. So you’re absolutely right it comes down to what is your spending going to average,… Read more »

Tanja @ Our Next Life
Tanja @ Our Next Life
2 years ago

Thanks for the shout-out, JD! And I certainly appreciate the validation of our plan. Of course now it turns out we’re earning money in retirement anyway, something we didn’t plan for (I’d rather overplan and oversave any day than bank on retirement income that never comes), but it all just gives us more insulation against sequence risk and more wiggle room for spending outlier years. Hope you are doing well!

Kit
Kit
2 years ago

It’s always interesting to read the draw down strategies. I’ll be honest I have no clue how I plan to deal with this yet. We’ve been on the hamster wheel for almost a decade and didn’t start thinking about FI until last year. I’m trying to convince my wife we can be FI in 5 years (she doesn’t think that is possible, she thinks 10 years is a stretch). But, since I am planning for this I should probably start looking into the post accumulation phase and how we want to structure that life.

Jason
Jason
2 years ago
Reply to  Kit

I agree with your thoughts and am in an similar place. Because the majority of people don’t do it, there are very few resources for those retiring early in terms of draw down. I will go into early retirement (whenever that is) with a 401k, ROTH IRA, Traditional IRA, taxable investment account, a pension at 55 and SS beyond that. Trying to engineer the proper withdrawals to make the money hold up and minimize my tax burden is a daunting thought, but one that I need to start evaluating.

Kristen
Kristen
2 years ago

We’ll be taking more like than the ‘safe’ withdrawal rate – we don’t have kids and I don’t plan to leave a nest egg behind!

Petra
Petra
2 years ago
Reply to  Kristen

I also don’t have kids, but the safe withdrawal rate of 4% means that you are at a very low risk to run out of money in 30 years. It can mean that you reach roughly $0 in year 30. I plan to live at least 30 years in retirement, don’t you? I wouldn’t want my last years (probably the most frail ones) to be filled with money troubles as well…

Coopersmith
Coopersmith
2 years ago

Yeah… as approaching retirement I am thinking more and exploring more on the safe withdraw rate. My wife will retire from full time teaching and that is the first step. Getting use to her pension and changes that involves with that. Next is what sort of income I can generate from the current portfolio of savings will be the next test. Then it is the moment of when. Hopefully sooner than later. Yeah I found out about FIRE or FI a little too late so I am looking at how soon I can retire at 59 1/2 being 56. 59… Read more »

WantNotToWantNot
WantNotToWantNot
2 years ago

Here is our strategy: I’m retiring in 18 months and have been working for the past couple of years on how to drawdown, and how to protect us in the first years of retirement when research shows a market downtown can be the most damaging. Our situation is this: my SO is over 70.5 and required to take SS and RMDs (required minimum distributions). We can live on that alone if necessary. On retirement, I’ll still be five years from RMDs or SS. To give us a fudge factor during that five year period, I’m setting up a CD ladder… Read more »

mary w
mary w
2 years ago

If you haven’t looked at your strategy since the US tax changes, please do so. It could make you accelerate your Roth conversions. For example MJF 25% bracket use to go up to ~155K. Now the 24% bracket tops out over 300K. (Although investment income over 250K AGI has an ACA surcharge you might want to avoid.) Especially if you think these low tax rates can’t last you may want to accelerate conversions.

In fact, everybody ought to look at taxes under the new rates to determine if there are changes they want to make.

WantNotToWantNot
WantNotToWantNot
2 years ago
Reply to  mary w

Dear mary w! Wonderful comment and yes indeed, the new tax law is complicated and with a different outcome for every case. I had our tax accountant run what-ifs for this past tax year (under the current rules and under the new ones), and the same thing for next year so we could make plans. And I join in your suggestion that everyone should do this. One thing the what-ifs showed is that the Roth Conversion won’t make sense for us this year or next. We have high taxable income for another 18 months, so we’ll adjust philanthropy giving to… Read more »

S.G.
S.G.
2 years ago

I wonder if spending is variable partially BECAUSE your income is variable. I intend to have an income plan and income over and above what i need will filter back into my post tax account. Otherwise I’ll under spend. Right now we have the promise of pensions through our employer that will more than cover our expenses by the time retirement comes around. But they froze the pension to new hires 7 years ago or so. I expect they’ll cash it out long before i start drawing mine. If so I’m not sure what I’ll do, but i have plenty… Read more »

Franklin Bach
Franklin Bach
2 years ago

I hit my minimum FI number of 25 a couple of years ago and succumbed to the one more year syndrome until June 1 when my position was eliminated. The plan now is burn the cash that I accumulated in money market accounts and not touch the stock portfolio, 401k and IRAs until 62. My 4.5% withdrawl rate is projected to last my predetermined five year “float” period. The investment money will continue to grow for the next 5 years while my cash supply is being used to live off of. I was so good at the accumulation phase and… Read more »

EP
EP
2 years ago

I’m 29 and have managed to save 25k in roth ira so far.

i’m only putting in 2% of salary right now (2 kids+only source of income) but I plan to do 10% once I reach 35.

I also plan on withdrawing ~80-100k per year @ retirement of 67+

enjoy reading your articles

Tyler Karaszewski
Tyler Karaszewski
2 years ago

> The fundamental problem with any ‘safe’ withdrawal rate is the underlying assumption of level spending over time I agree. To extend this further, this is the problem with *most* financial advice, not just withdrawal rates. For instance, given this: > Over the past decade, I’ve had zero years of earning and spending that I could consider normal. Zero. Then, how can I possibly know this? > you’re financially independent once your savings reaches 25 times your annual spending I feel like there’s some cognitive dissonance going on here. Another interesting thing to consider is this: > Obviously, it’s no… Read more »

Nadeem
Nadeem
2 years ago

Tyler,

You make an excellent point. I contemplate this everyday when I drive into work and back home. The question of what if we choose a less safe withdrawal rate just to take a break and come back to work if need be. This is harder to convince your SO though. I think earlier retirees have a slightly better outlook of re-joining the workforce if needed after a few years of being out of the game.

J.D you should do a blog post on this topic, as well as the break even point of delaying SS payments to life expectancy.

S.G.
S.G.
2 years ago

My questions are on the other side of the coin. As the balance of your savings decrease at an ever faster rate, at what point do you second guess your strategy and alter behavior? Unless you have a secondary income that would cover expenses I can’t imagine anyone just riding that train into the wall. It works only if you are only taking a small amount off the top (i.e. your spending is close to growth, keeping principle mostly intact) or have payments until death (pension, annuity, or SS). I can’t imagine it working any other way. It seems like… Read more »

RichardP
RichardP
2 years ago

Approaching retirement, I started by selling my taxable mutual fund accounts. Certainly the long-term gains are taxed favorably, but that wasn’t the big advantage. Most of the shares in the accounts were purchased from distributions each year – which were taxed in that year. So a $50,000 account might have a cost basis around $42,000 and result in a taxable gain of only around $8000 (actual example from one of my accounts – obviously every account/fund will vary). In retirement, now that my income is much lower, I’ve been selling stocks in a taxable account. For 2018, my target is… Read more »

NWA-non
NWA-non
2 years ago

If your non-consumer, but discretionary, expenses are depleting your portfolio enough to make you feel worried, aren’t you, in some way, reneging on the most fundamental contract of building a life towards financial independence? That you shouldn’t be spending more than you earn. Even though these expenses are non-consumer, as you put it, they are still discretionary. You’re still choosing to buy a RV, a house, a blog. I understand that certain big expenses could very well be non-negotiable, such as a health concern. Premiums for health insurance and one time costs for catastrophic events should probably be built into… Read more »

Adam @ Minafi
Adam @ Minafi
2 years ago

The move to use dividends for yearly expenses sounds like a huge tax win. You mentioned your long-term capital gains are taxed at 15% – is it realistic to find out how to lower your income low enough to take advantage of 0% rates? We’re still penciling in our plan today, but a lot of it sounds similar. I have a lot of cash in post-tax accounts, which means figuring out taxes early: • Try to keep total income under $77,000 (jointly), allowing us to pay 0% in capital gains taxes. • Hold a similar amount to you (~6 months) in cash.… Read more »

G. H.
G. H.
2 years ago

I retired 3 years ago, in the year I turned 55. At the time, we had about 3 months worth of expenses in taxable savings or investment accounts, with the rest in IRA’s or my 401K. Most of the 401k money was rolled into a Roth IRA, but about 2.5 years of expenses was left there, since I can pull from the 401k without penalty before I hit 59.5, something I can’t do with my IRA’s. We have no real income – less than $500/year in interest/dividends; everything else comes from retirement account draw-downs – usually around $20K several times… Read more »

The FIminator
The FIminator
2 years ago

Thanks for sharing this J.D. This is an issue I have internalized for quite a while. Being a freshly semi-retired FIRE, I had the same fear as others, would the money last for the rest of my life. As I am reasonably conservative, my approach was to wait a bit longer & have at least x 30 my annual expenses. I also work on a number of small projects that give me multiple but small streams of income to supplement the passive income.

Ron Cameron
Ron Cameron
2 years ago

I love William Bengen’s research and have read lots of his stuff, including that Reddit AMA. But I can’t understand why he says people who retired in 2000 appear to be “doing ok with 4.5%”. My quick math says that someone who retired in 2000 with $1m drawing $45000/yr+inflation on a 75/25% stock/bond portfolio now has less than $500k left and is drawing a very unsustainable 10%+ a year. I can’t seem to find a place where I can see his math and understand where I’m wrong. In this scenario it appears the 4% rule (nevermind 4.5%) is very, very… Read more »

Bob at The Frugal Fellow
Bob at The Frugal Fellow
2 years ago

Good point about unanticipated and/or rising costs in retirement. My opinion of this is that you should simply save as much as you possibly can. You should still do the math and try to at least get to 4%, but that isn’t a reason to stop saving. You can never be too safe!

3rdnooj48
3rdnooj48
2 years ago

I do not reinvest dividends in my taxable accounts and that is working well the last 18 months. Then I sell equities as needed quarterly to ensure my cash never goes below one year budget ($60K). Having $60K in MMA gives me peace of mind for any emergency expenses, but none so far since I retired in 2017. Am about your age – turning 50 this year and I retired at 48. My annual personal budget is $60k ($36K essential/ $24K discretionary). My withdrawal rate is 3% (75/25 allocation) and I do not include social security in my net worth… Read more »

carrie
carrie
1 year ago

Thank you very much for giving us a real numbers post about how things are in REAL life.

I have been reading your stuff for a long time and really appreciate it.

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