Thursday, October 24, 2013

Enough Already With the 4% Rule

In David Ning's October 23, 2003 blog titled, The 4 Percent Safe Withdrawal Rule Declines to 3 Percent,Mr. Ning says that most investors will "do fine by sticking with a flexible version of the original 4 percent retirement rule."  His proposed modification to the 4 percent rule to make it "flexible" is to "pause the inflation adjustment when markets decline."  Of course, he doesn't say how long the pause will be required.  It is now about 5 years since the stock market crash of 2008.  Is it now ok, under Mr. Ning's proposed modification to recommence inflation adjustments?

As I have said many times in this blog, the 4% Rule is far from an optimal decumulation strategy.   And making unspecified modifications to it to address some of its flaws does not make it appreciably better.  Rather than rely on set and forget strategy that is supposed to be "safe" with respect to the risk of outliving one's assets (but may result in significant underspending), you need to periodically crunch your numbers based on your situation.  The spreadsheets and actuarial process set forth in this website make this task relatively easy.

Let's look at three different retirees, each with $500,000 of accumulated retirement assets.  Based on the spending spreadsheet in this website and the recommended assumptions discussed in my previous posts,  I will show you that if you desire constant inflation adjusted spending in retirement, there is no x% withdrawal rate that will work for all situations.

Robert retires at age 65, has no bequest motive and no other sources of retirement income (other than Social Security).  Using the Excluding Social Security 2.0 spreadsheet and the recommended assumptions discussed in my previous post, Robert can withdraw $21,725, or 4.3% of his accumulated savings in his first year of retirement.

Ray retires at age 75.  He has a deferred annuity starting at age 85 of $35,000 per year and no bequest motive.  Inputting his information into the spreadsheet and the recommended assumptions shows that Ray can withdraw $40,220, or 8.04% of his accumulated savings in his first year of retirement.

Richie retires at age 60.  He has an immediate life annuity from his company's pension plan of $20,000 per year and he wishes to leave $250,000 (in nominal dollars) to his heirs when he dies.  The spreadsheet says that he can withdraw $11,049, or 2.21% of his accumulated savings in his first year of retirement.

So, while Robert might be ok using the 4% rule, Ray may be significantly underspending and Richie may be significantly overspending if they use it.