Fire the 4% Rule

You have probably heard of the 4% rule as the strategy for withdrawing retirement funds so they provide inflation adjusted income for a thirty-year period. That strategy was developed under a certain set of assumptions. Trying to make the rule work beyond those assumptions – such as retiring at 45 – probably will not work.

Fire the 4% Rule Greg Spears  |  Jan 25, 2022, 3:17 am ET

I DID ACHIEVE financial independence and retire early—if you count age 64 as early. My friend Jose, a true believer in FIRE, or financial independence-retire early, celebrated his retirement at 44. That took a steely nerve that I lacked, plus I had big college bills to pay before retiring.

One big challenge of FIRE, of course, is that your savings might need to last 40 or even 50 years. Vanguard Group recently published a research paper to help FIRE followers go the distance. It includes major tinkering with the 4% rule, which was designed with only a 30-year retirement in mind.

Under the 4% rule, you withdraw 4% of your savings in the first year of retirement, then raise that dollar amount by the rate of inflation in the second year and so on thereafter. This approach worked 82% of the time over a 30-year period with a 50% stock-50% bond portfolio. If retirement gets stretched to 50 years, however, the success rate fell to a discouraging 36%, Vanguard’s researchers found.

To improve the odds, they suggest FIRE followers try these four steps:

Enter truly big numbers into your retirement planning calculations, by assuming, say, a 50-year retirement. The standard assumptions of a 20- or 30-year retirement could produce false positives for FIRE followers.

Slash investment costs. Even relatively modest annual costs of 0.2% cut the odds of 50-year success down to 29%. Index investments can cost one-third of that sum or less at Vanguard and, incredibly, nothing at all at Fidelity Investments.

See the world. The 36% success rate was based on an all-American portfolio. The odds of 50-year savings survival jumped to 56% when 40% of the stock allocation and 30% of the bond allocation were invested internationally.

Adjust the 4% rule to withdraw less money when account values are down. The chance of savings lasting 50 years leaped to 90% if retirees withdrew 1.5% less when their account balance fell below last year’s. Example: If you withdrew $40,000 in year one, 1.5% less works out to $39,400 in year two. Happily, the model also permits larger withdrawals if account balances are higher, such as $42,000 in year two.

There are no automatic inflation adjustments under this dynamic spending model, so the shoe would pinch if higher inflation turns out not to be “transitory.” Still, the concept follows human nature: Tighten your belt when balances are down and spend a bit more when they’re higher.

Does this mean the 4% rule is repealed? Not really. FIRE followers who adhere to all four steps could start with a 4% withdrawal rate, the researchers found, and have at least an 85% chance that their savings would last a full 50 years. Your results may vary, of course. Good luck, Jose. Read more by Greg Spears

Source: Fire the 4% Rule – HumbleDollar

10 comments

  1. The RMD is almost always overlooked during withdrawal discussions. I believe it is as sound a withdrawal technique as any other and a heck of a lot simpler than some of the caveats that go with other strategies. Just take the required withdrawal and reinvest what is not spent, if any. An index fund like the S&P 500 fund can keep expenses down in a taxable account.
    I’m past the age of having to make funds run out to 40-50 years so I don’t really get into the FIRE business.

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  2. That’s very true and you rarely see that implication mentioned. But consider the rule was intended to make assets last 30 years 65-95 on average whereas RMDs start at 72. I am in the same boat, on my 8th RMD. I reinvest the net distribution when it’s not needed.

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    1. Dick. I’ve read yours and many others regarding the 4% rule but I am questioning it’s validity in relation to having a 401k requiring an RMD distribution. If the required distribution is say 4% and inflation is say at 3% wouldn’t one need to make at least 7% in their 401k to “break even”, ie, maintain their balance as of December 31 of any year? Which is the date your Yearly RMD withdrawal amounts are determined. I’m very interested in your and others viewpoints. If you comment please tell me where I can find it because I’ve commented in the past but did not see a reply.

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      1. The 4% rule starts with 4% of retirement assets and that amount is fixed. Say it’s $40,000 (4% of $1,000,000) that amount is increased by inflation. So if inflation is 3% the next year withdrawal is $41,200, etc. The idea is it depletes assets over 30 years.

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      2. Maybe I always had this wrong but I thought that if in 2021 you took out 4% ($40,000 on $1m) with $960,000 and the remainder would have to earned 12% or better in 2021 if it was left in the markets. Now in 2022 you can take 4%, which now will be $43,008 (depending when you made your withdraw) of $1,075,200. Even if 2022 is a lost of 4%, you still have 4% margin for 2023 from your earnings in 2021. Usually inflation is less than 4% unlike the current rate of 7%. And the market growth is greater than 4% unless your are extremely conservative in your investments.

        If you took out $40,000 per year and had a ROR of 0.0%, your money will only last 25 years. Less if you need to increase your withdraw to keep up with inflation. But anybody who has a $1m retirement fund that is getting 0% ROR needs to seek some professional advice.

        Now I was surprised that the Vanguard Group study runs out of money. Did they expected that their ROR was always going to be less than the rate of inflation? I fully expect using the 4% rule to last at least 30 years unless totally invested in bonds or something. The only other issues is a big medical bill which would require withdrawing more than 4%.

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      3. How did you get the $43,008 number? You only have to earn a little over 4% to get back to $1,000,000. Typically markets return 6-8% a year depending on your investment mix. There will, of course, be up and down years.

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      4. For the example, I assumed that I would have made the $40K withdraw on January 2, 2021
        $960,000*12% (ROR for 2021 only for me) =115,200 + 960,000 = 1,075,200 * 4%= $43,008 on January 2, 2022.

        Yes that only worked for last year and may depend if you took the money out in January or December. Some people might have a better than a 12% return, others worse. Even if your average ROR is 6-8%, you should still be banking more than 2-4% above what you are withdrawing at 4%. As long as inflation is less than 2-4% you should not be withdrawing your principle. Since your nest egg might have grown that extra 2-4% your 4% withdraw should be more than the year before.

        But this still does not mean that you will not run out of money. Inflation is currently 7%. The DJ is currently down 4.4% (was down 6% on Thursday). If you retired and the market was down three years before going up, that might be a problem. But when you have a big ROR year, that may help in the lower returning years.

        Another thing is there may come a point in time where you nest egg continues to grow. If you only need $40k that is adjusted for inflation to live on, you do not need to spend $50k or $60K. You could invest the difference if you like.

        In an ideal perfect world, if your ROR is 4% and you withdraw 4% (not counting on needing extra to cover inflation), you should never run out of money or use your principle. But market timing is every thing and mostly dumb luck, so over time you may spend down your principle. You may have to make a large withdraw for medical too.

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  3. Dick: I am a long time follower of your columns. I have disagreed with the 4% from the beginning. That is simply because a lot of retirees (like me) have most of the their assets in an IRA. I just looked at my schedule of RMD withdrawals and I am at 4% for 2022. All withdrawals going forward will continue to increase thanks to the IRS actuarial tables. The 4% regime does not take into account RMD withdrawal schedules which many retirees will have to adhere to.

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    1. Dick. I’m sorry but I’m confused by you reply to me. If you have to take out 4% each year (assuming 4%is a fixed rate which it is not every year by the tables), and inflation is say 3%, how do you make up 3% and the 4% RMD every year to maintain $1000000? It seems to me you have to have a return on your 401k of 7-8% overall to maintain it and the value if your money. Forget about when it runs out.

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      1. The 4% is a fixed number. If you start with $1,000,000 you take $40,000. If inflation is 3% the next year you take $41,200 and the next is $42436, etc. The goal is not to maintain the $1,000,000, but to make your starting total last for at least 30 years. It will gradually decrease over the years and no doubt will go up and down over those years.

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