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Goodbye 4% Retirement Spending Rule: Popular Rule of Thumb Eclipsed by New Theories

Category: Financial and taxes in retirement

Nov 20, 2012 — New research suggests that the traditional rule of thumb for how much you can safely take out of your retirement funds, 4% per year, is not the ideal tool for the job. Originally popularized by Bill Bengen in 1994, it was at least partially based on the assumption that traditional stocks and other investments would return 6% or more over the long haul. As reported by Robert Powell at WSJ MarketWatch in “Retirement Income: What’s Wrong with the 4% Rule” and the Center for Retirement Research in “Can Retirees Base Wealth Withdrawals on the IRS’ Required Minimum Distributions?”, several exciting new theories challenge the traditional 4% orthodoxy.

Not so long ago most retirees didn’t have to worry about how much to take out of their retirement savings. That’s because they had pensions plus social security – retirement savings just weren’t that important. But today in the age of 401k and IRA savings the question is absolutely critical – what you have in those accounts has to last as long as you (and your spouse) do. This article will cover some new and emerging ideas about the age old question – “How much can safely take out of your retirement account – and not run out of money”!

Balancing Income with Safety – Competing Approaches
Managing retirement wealth involves trading off the enjoyment of spending one’s assets on consumption against the risk of spending too much and prematurely depleting one’s resources. The first of the competing theories was explained by David Blanchett,the head of retirement research at Morningstar Investment Management, at a recent Retirement Advisor conference sponsored by WSJ MarketWatch. In Blanchett’s paper he compared 5 competing ways to determine the optimum retirement spending rate. The 4% rule, a constant percentage method, is the 2nd of those – (others include constant dollars and remaining life expectancy). The good thing about the constant income or constant percentage approaches is that your income will be fairly stable over time, since you decide at the beginning how much you were going to take out each year. But according to Blanchett a better theory is the “Probability of Failure Mortality Updating” method. In that approach you continue to recalculate the withdrawal amount based on your expected longevity, adjusted for the “failure” risk that your remaining investments might tank. A simple explanation is that at age 65 you have a life expectancy of around 85, so you need to take that length of time into account in your distributions. But, once you make it to 75, you have fewer years to worry about, so you can withdraw at a much higher rate. A drawback is that younger retirees might be able to use the money more than older ones, although not if you have expensive medical problems or have to move to assisted living.

The second theory like we like even better for its simplicity was researched by Wei Sun and Anthony Webb of the Center for Retirement Research at Boston College. Their theory builds on the RMD (Required Minimum Distribution) method required by the IRS. The RMD requires that when you reach age 70.5 you have to begin disbursing your 401k and/or IRA according to a percentage that changes with your life expectancy each year.
The required IRS distribution percentage starts at 3.13% at age 65 and goes to 15.87% at age 100. The authors also explain competing withdrawal strategies that a retiree might consider. Those include the “interest only” approach (withdrawing only the interest earned on your retirement account), the fixed percentage, and the IRS’s RMD approach, among others. Sun and Webb believe that the RMD approach is superior to the 4% rule because it continually adjusts for life expectancy.

A Hybrid Approach That’s Even Better
Sun and Wei believe there is a hybrid of the RMD strategy that works even better. According to them the highest performing retirement withdrawal approach modifies the RMD by adding in interest and dividend income, but not capital gains. This modification gives extra income to younger retirees without jeopardizing future losses to inflation. Here is how they explain it in their paper:

“To illustrate, a 65-year-old couple with financial assets of $102,000 who received $2,000 of interest and dividends in the last year, would spend $5,130: the $2,000 in interest and dividends, plus 3.13 percent (the age 65 Annual Withdrawal Percentage under the RMD strategy) of $100,000. In contrast, a household following the unmodified RMD rule would spend just $3,130.”

The Bottom Line
If you are fortunate to have saved significant amounts of money for your retirement, congratulations. You have done the hardest work. Now you have to make a decision on the optimum way to spend your saving so as to maximize income and minimize the risk of running out – and that decision is not as cut and dried as you might have thought. As this research points out, simply deciding once and forgetting about it strategies aren’t nearly as effective as careful year by year review of the situation. Making financial decisions of this much importance are difficult, so we always recommend that you consult a qualified professional before acting (but make sure they know about this research). Good luck!

For further reading:
What is Your Number?
Is Even $1 Million Enough?
Can You Afford to Retire and What If You Don’t Like the Answer
Firecalc is a free tool that gives you probabilities of success against different rates of return.
Rival Spending Theories Keep Popping Up

Posted by Admin on November 20th, 2012


  1. Interesting article and very timely. Rules are changing fast and, as a couple who will retire soon with a modest nest egg and a family history of longevity, we are constantly calculating to see if we’ll have enough. As the article mentions, few are lucky enough to receive a pension now. However, my husband is one of the lucky ones and, although it isn’t enough to live on, it will definitely help us avoid tapping savings for several years when we retire. We hope to go as far as we can on the RMDs on our pre-tax accounts when the time comes (maybe just rolling some into after-tax savings) and not touch the Roth accounts unless absolutely necessary. We just feel vulnerable because we can forsee how one really bad medical situation could be a huge game changer.

    by Genie — November 21, 2012

  2. If I withdraw 4% once a year, when do I withdraw?

    by Charles Kavin — November 21, 2012

  3. Kavin, if you withdraw from a 401k or IRA, the optimum time to withdraw is in December of the year following the RMD. That allows your money to stay in the tax sheltered IRA or 401k, earning in a tax free environment.

    For example, if your calculated RMD for 2012 is $30,000, take that out in December, 2013. You have until 12/31 of each calendar for the distribution. Or stretch it out in quarterly or monthly distributions throughout the year, if you need the money to cover expenses in the current year.

    by Jeanette — November 21, 2012

  4. A question: How do these new methods of estimating apply to those who have inherited IRA’s and were required to begin distributions at a younger age? Assuming the beneficiary retires at 55, and begins distributions at 55, the IRA will need to cover a longer period of time than the usual withdrawal period. In that circumstance, the two new methods describe seem risky to me.

    by Jeanette — November 21, 2012

  5. I don’t think that most people are that scientific when it comes to drawing down their retirement funds. In my opinion, the 4% a year rule of thumb is about as good as any. I don’t think people are going to study mortality and actuarial tables on their own. There are going to be better years when your investments and savings earn a good rate of return and those years where there is no growth and the possibility of losing ground. This is what most of us long term investors have been experiencing since 2008. While the market has recovered considerably from falling off a cliff during the real estate and banking fiasco, it hasn’t advanced to any new highs since that time. So, unless you are a “trader” who can beat the odds consistently, many of us have been treading water for a while now or in recovery mode. In good years, you might be tempted to draw a little more than you would ordinarily. And there might be a good reason to draw more money down while your still young enough to enjoy it and get around a bit. You can make these kinds of “common sense” decisions without being overly scientific.There are a lot of unknown variables to be considered, like one’s health. The biggest problem with retirement planning is that most people don’t have a plan at all and are clueless just how much money it takes to retire reasonably comfortably these days. Unless you have some kind of pension as one piece of the retriement pie, the amount you need to save and more importantely invest on your own for retirement is obviously that much more of an issue. A million dollars, while sounding like a more than sufficient amount of money to retire on, is not what it used to be. You can’t just park this money in a bank. And, how many average working Joes have managed to accumulate that kind of account anyway? Too many people don’t take the time to learn to invest and are too cautious with their money. Inflation and the increase in the cost of living has been around 3 percent on average over the years. So, unless you are earning more than that, you are losing ground and this is notwithstanding the impact of taxes.This is especially critical in the case of low paying fuxed income CDs and a portfolio weighted too heavily in bonds. Even with the ups and downs of the stock market, you need to have stocks and some other equity type investments to keep up with inflation. Real estate used to be a no-brainer..however, we have seen that even that sacred cow needs to be re-evaluated in light of the current market. Let’s hope this country gets it’s act together. As individuals we are expected to be fiscally responsible and know how to balance a budget. It doesn’t help that our country can’t seem to understand and accomplish this.

    by Artiie — November 21, 2012

  6. All the percentage based approaches are fine but simplistic. A better way to approach distributions is to actually prepare (or have your financial advisor/accountant prepare) a reasonably detailed cash flow forecast for each post retirement year, and then review and update it each subsiquent year. A monthly cash flow for the current year will answer Mr. Kavin’s question about the timing of the distributions. The advantage of this approach is that it allows you to make conscious decisions about the various financial trade-offs most of us face in retirement before they sneak up on you.

    by Pat Sidley — November 21, 2012

  7. We started taking out 4% a few months ago. We take it evenly each month to supplement our pension and social security. Our financial advisor at Fidelity convinced me to take 1/3 of my IRA and put it into an annuity for 5 years. This way we were assured of steady income without the ups and downs of the market impacting the entire portfolio. We use 2/3 of our monthly payment from this annuity. Since we are in our early 60’s, we realize we have to plan for a fairly long time (hopefully!).
    Every year, we go through a detailed review of our expenses and needs with our advisor and know where we are at. It seems to work out well for us.

    by Locobill — November 22, 2012

  8. I am not using my income from my IRA at this point. I was, unfortunately, one of the many people who was hoodwinked during the last decade; I had two IRAs, and I self-directed the smaller one and invested in a gold investment, at the advice of numerous friends. The ‘gold mine’ turned out to be a hole in the ground and the investment was a ponzi scheme. The perpetrators are currently on trial in Alberta, Canada, but I will never see that 250K again. Since I lost effectively half of my retirement money, I must be very careful with what I have left. My current plan is to take out about 3% to 3.5% a year, if needed, and continue to work part-time to supplement my income and social security. I have hope that the economy will improve and I want to have as much as possible in the account; the more capital, the more growth. I think delaying using the funds is a good tactic right now.

    by Ginger — November 23, 2012

  9. […] and 401(k) – An Owner’s Manual Not So Much – A Million Dollars for Retirement? Goodbye 4% Retirement Spending Rule Eclipsed by New Theories What Is Your […]

    by » How Much to Take from Your Retirement Funds? Some See RMD as Guideline - Topretirements — October 12, 2014

  10. All these methods seem to assume all of your money is in a single basket to withdraw from. We have an after tax account and each of us has a Roth and an IRA. These 5 accounts have different investments that may or may not be at a point I would like to sell. There are different tax situations in withdrawing money from IRA vs Roth vs after tax account.
    eg: profits taken in the after tax account are taxable as well as dividends.

    In the Roth and IRA you can take profits without giving any consideration to tax consequences.

    Having all of it in a single basket would make life much simpler.

    by Clarence — October 20, 2014

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