What is the 4% Rule and Should I Use It?
What is the 4% rule and should I use it? These are questions we hear often from clients and potential clients. The 4% rule was created by William Bengen in the 1990s. After research into historical rates of return on stocks and bonds, Bengen concluded that 4% was the largest annual withdrawal rate one could exercise on their savings if they wanted their savings to last for 30 or more years. The idea is that in the first year of retirement, one would withdraw 4% of aggregate savings and then each following year increase this withdrawal number in direct proportion to inflation. For example, if a couple has $1,000,000 in savings and inflation is 2% a year, they would withdraw $40,000 (4% of their savings) in their first year of retirement, and $44,800 the second year and so on.
So should you use the 4% rule? Is it too ambitious? Is it too conservative?
Many Financial Advisors think that a 4% annual withdrawal rate is in fact too ambitious and that a 3% rate is more appropriate for most retirees. Sure, a 3% annual withdrawal rate means less cash to spend every year than a 4% rate, but it also provides a higher level of assurance that a retiree’s savings won’t run out prematurely – and what could be worse than that?
However, other Financial Advisors, such as Michael Kitces, are quick to point out that there has not been 30-year period over the past 150 years in which a retiree employing the 4% rule would have run out of money. Instead, Kitces notes that about two thirds of the time one employing the 4% rule would end up with more than double their original principal!
What does the future hold? How will markets perform? No one knows and, yes, it is possible to encounter a 30 year period in which a retiree following the 4% rule would run out of money.
Ultimately, it is nearly impossible to accurately forecast a perfect withdrawal rate that would both protect a retiree against the risk of running out of money without also leaving him open to the risk of ending up with more savings than he needs later in life. At Catamount, we understand that your situation is unique and that you can’t always rely on a simple formula to guide your retirement plan. Together, we can establish and continually adjust your withdrawal rate so that it meets your needs and ensures you won’t outlive your money. We would be excited to help you start planning for your retirement today! Please contact us for more information or any questions you might have. We are always happy to chat. firstname.lastname@example.org, or 203.226.0603.