Is the 4% Spending Rule Still Relevant Today?

Category: Financial and taxes in retirement

Aug. 21 2018 — Fortunate retirees, those with a good amount of retirement savings, agonize over a perplexing problem: how much can you safely take out of your retirement funds? Spend those hard earned savings too fast and, if you live too long, live in poverty. Hold on too tightly, and you will go on to your greater reward with a big pile of unspent money in the bank. Your heirs will be able to fly first class, even if you didn’t!

The traditional rule of thumb for spending is the 4% rule. Originally popularized by Bill Bengen in 1994, the idea was pretty simple – you have pretty good odds of spending of not running out of money if you take out 4% of your savings every year of retirement. The theory is at least partially based on the assumption that traditional stocks and other investments return 6% or more over the long haul. While that has been true for equities since 2009, anyone invested mostly in bonds or CDs during this span would have experienced a much lower return.

Like all theories, however, the 4% rule might not apply to everyone. For example, if you have substantial earnings in retirement, or if you have a nice pension, withdrawing 4% would have you seriously underspending. If you have major expenses late in life, you might not have enough money left.
budget-rectangle

Balancing Income with Safety – Competing Approaches
There are many competitive solutions to the spending conundrum. One different approach is the constant dollars approach (take out the same amount of money each year, regardless of investment performance). Another is the remaining life expectancy theory (keep adjusting the payout to reflect your adjusted life expectancy).

David Blanchett, head of retirement research at Morningstar Investment Management, has explained what he thinks is a better theory, the “Probability of Failure Mortality Updating” method. In that one 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 of risk, so you can withdraw at a much higher rate. A drawback is that younger retirees might have more uses for the money than older ones.

A hybrid approach to the RMD Method
Another theory like we like even better because of its simplicity was researched by Wei Sun and Anthony Webb of the Center for Retirement Research at Boston College. Their RMD Plus 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 each year with your life expectancy. The required IRS distribution percentage starts at 3.13% at age 65 and goes to 15.87% at age 100. Sun and Webb believe that the RMD approach is superior to the 4% rule because it continually adjusts for life expectancy.

But 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 savings so as to maximize income and minimize the risk of running out. That decision is not as cut and dried as you might have thought. In our opinion, the 4% rule, where you simply decide once and forget about it, isn’t nearly as thoughtful as a careful year by year review of your situation.

Making financial decisions this important are difficult, so we always recommend that you consult a qualified professional before acting. A good way to evaluate a professional, besides checking out their references, is to probe to see how much they know about the different withdrawal theories that exist, and ask which is the best for your unique situations. Good luck!

For further reading:
How Much Can You Take from Your Retirement Funds: RMDs as a Guideline?”
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.




Posted by Admin on August 20th, 2018

32 Comments »

  1. I am struggling with this issue and read everything I can. Thanks for the timely article. I retired with a paid-off house, no debt, the magic $1M in appropriately diversified funds in my 401K plus approx $27K in Social Security at 65 (widow benefits – I plan on waiting til 70 if health is good since my own benefit will be higher). My budget is much less than this amount. I thought the 4% rule would give me a cushion (plus if earned 4% or more each year, that $1M would still be there at 70 when the RMDs kicked in and replaced my 4% withdrawal. I could be short-changing myself with this strategy. I definitely could be tempted to spend more in years 65-70 on travel, toys and contributions to grandkid’s 529.

    by Kate — August 21, 2018

  2. Since we retired our financial advisor has done an excellent job. With his fee and our monthly distribution from our IRA has been relatively steady in total assets, we have not seen a drop. Our next step is to talk to an estate planner, so we can see the options related to leaving something for the grandchildren and children. We are also considering moving some funds from the traditional IRA to a Roth IRA. Yes I know we will need to pay the tax, but u will at 70.5 anyway.
    We are holding off as long as possible in taking SS. Receiving 8% guaranteed growth would even be difficult for our IRA account to achieve.

    by Bruce — August 21, 2018

  3. Since we both are now retired for year, our IRA has held its value, even after paying our financial adviser fee and our monthly distribution. We basically are on the same budget we were on before retirement, the only difference is lower taxes and house costs. Our next step is to talk to an estate planner, we like to set up a few accounts for the grandchildren and let them grow before they need it for school or a major purchase.
    Like you Kate we are waiting on taking SS. With 8% guaranteed growth after age 66, it would be difficult even for our IRA to achieve that.
    Have been kicking the possibility of moving some dollars into a Roth IRA. Yes, I know we will pay the tax for the withdrawal, but at 70.5 you will also. The Roth account will not be subject to the RMD rules.

    by Bruce — August 21, 2018

  4. Here is a RMD calculator you can play with. I find it very interesting:

    https://www.schwab.com/public/schwab/investing/retirement_and_planning/understanding_iras/ira_calculators/rmd

    by Louise — August 21, 2018

  5. FWIW, I’m 65, retired, and not drawing SS (waiting until 70, unless something changes in my life expectancy). I may begin accelerating converting my standard IRA to a Roth since I expect taxes will never be lower and it may result in less of a tax hit when I start drawing SS plus RMDs. Effects I’m considering by increasing my taxable income are higher Medicare premiums and loss of a senior tax break on my property taxes. But after so many decades of saving and investing, it’s very hard trying to unwind investments and change my mindset regarding money. I’ve certainly never lived as a miser, but I’ve never required a whole lot either. Then again, I guess I could have worse problems.

    by Peder — August 22, 2018

  6. No one has mentioned the biggest risk of all – a big horrible Bear cycle in the stock market, especially if you are recently retired. It won’t make much difference if you are taking 4% or RMD’s in income if your $1 Million portfolio craters to $700K, or $600K or lower. We are in the late stages of the longest Bull market in modern history, stock valuations are approaching levels not seen since the late 1920’s, the late 1990’s and 2008.
    See for example : https://www.advisorperspectives.com/dshort/updates/2018/08/02/market-remains-overvalued

    If you are feeling comfortable, that’s a normal human response to 9 years of a steady rising market with little or no volatility, the more comfortable you feel, the bigger the danger to your portfolio. And don’t think your financial advisor will protect you. 1.) They are emotional human beings just like you and 2.) They have a significant conflict of interest since they only get paid to the extent you are invested in stocks and bonds. The industry’s basic mantra is buy and hold. The problem with that is almost no one can ride through the entire cycle, most sell near the bottom with huge damage to their net worth and emotional scars which keep them from buying for a very long time. What to do? Reduce stocks, raise cash and buy more high quality 3 to 10 year bonds. Study the charts in the link above and you’ll see that high valuations are immediately followed by low valuations, hint – buy low valuations.
    Last note – Risk happens Fast !

    by Troutbum — August 22, 2018

  7. Troutbum,
    Everyone who rode out the last bear market had the value of their portfolios return to pre-crash value, and then continue to go up and up. NO ONE can predict what will happen or when. Wish it were that simple!

    by ella — August 23, 2018

  8. Husband and I looking to retire soon. This post is very timely and helpful

    by Ashley Hoober — August 24, 2018

  9. A bear market will most certainly happen at sometime, but predicting it is anyone guess. Since we retired our financial advisor has the IRA in much lower risk investments which don’t fluctuate with the highs and lows of the market. We rode out the last near market with the help of our financial advisor of 15 years and done well.
    We also adjust our monthly distribution as needed, we check in semi annual for those adjustments up or down, so don’t use a set percentage.
    Believe you must have a long term retirement plan and discuss with certified financial advisors the scenarios of up and down markets.

    by Bruce — August 24, 2018

  10. I cannot and did not predict when a Bear market will occur. But when valuations become deeply overextended
    ( See : https://www.advisorperspectives.com/dshort/updates/2018/08/02/market-remains-overvalued ) by 103% or has a standard deviation of 2.5X the 120 year mean average it’s just a matter of time. Radically overvalued markets always correct deeply. In the 2000 to 2002 bear, the NASDAQ 100 lost 83%, and the total return of the S&P 500 was negative for the next 10 years! In the 2007 to 2009 bear, the S&P 500 lost 55%. I feel quite certain that when the next Bear occurs, it will be one of the worst in history. Why? Because this market is the 2nd most overvalued in history only surpassed by the 1929 Bear. I would not be surprised to see stock losses exceed 60%. So, start by stress testing your portfolio with a 60% drawdown and assume a 10 year recovery just to get back to even. Now, how would that change your lifestyle?
    Risk happens Fast and Mr. Market does not care about your retirement.

    by Troutbum — August 24, 2018

  11. The problem with planning to stay invested during the inevitable downturn is that you will be selling your investments at a loss to take your MRD. That was an OK strategy when I wasn’t taking distributions. Now it could cause a huge hit. My sister, a CFA, recommended that I get ten year’s worth of distributions in cash in order to survive a market meltdown. So, a lot depends on where you are in the retirement cycle.

    by Linda — August 25, 2018

  12. Linda,
    Great advice; thanks so much! Almost all of our cash is invested in annuities outside of our IRA’s and 403B’s, thus won’t be included in our RMD’s. I’ll be definitely looking into what to do about this!

    by ella — August 26, 2018

  13. My advisor advised me to keep 5 years of cash in a money market account for a bear market run. An average bear market will last average 5 years. As your other accounts make you money in a bull market you add to or replenish your money accounts. Is this a perfect option? No but what option is perfect?

    by Skip P — August 26, 2018

  14. I only have 2-3 years in a money market in my 401k, which is probably too aggressive. My plan was to take my distribution from the money market each year. If the market performed well, I could sell something and replenish the money market to keep that account at the 2-3 year level. If the market didn’t perform, I’d spend down the money market and hope not to have to sell anything until I had used up the 2-3 year account (also planning not to spend everything in my budget each year, to save some money outside of the 401K in a doomsday case in which distributions from the 401K didn’t meet my budget).

    I also recently decided to get a line of credit on my paid-off house, as an additional source of emergency funds. That was an interesting exercise now that I’m retired. Even with a credit rating in the 800s, no debt and equity that would exceed the line of credit several times over, the bank wanted confirmation of my social security income, copies of every brokerage and bank statement, sent an appraiser out to inspect & take lots of photos of my home, copies of insurance certificates, verification of HOA fees and assessments, etc. I wish I had gotten the credit line put into place when I was still working and credit was easy to get! Too bad a line of credit is only good for 10 years, but I thought this could add an additional safety net. I didnt pay any fees for the line of credit application and there will be no fee to keep it open, by the way.

    by Kate — August 27, 2018

  15. I put half my portfolio into an annuity that guarantees me 5.35% distribution for life regardless if the value falls below my initial investment. If it rises above my initial investment, it locks me in that higher return for life. I’m locked in for four years. If I die first, my spouse has the option of continuing or taking out the lump sum. The fees are a little pricey but worth the peace of mind during a bear market. As you age, it gets harder to wait out a bear market. You just don’t have the luxury of waiting 8 years for a recovery.

    by Tom — August 27, 2018

  16. I’m in the process of searching for a financial adviser. One source recently quoted me an expensive option – they would meet with me quarterly to the yearly cost of $$$$ based upon some point system. I’m now looking to find someone reliable who will charge hourly consult fee. Any tips how you found your financial adviser? Research for their quality of service and customer satisfaction?

    Editors Note: Good question JoannL. We have several articles on this topic you might find useful. Here is one of them https://www.topretirements.com/blog/financial/3-steps-to-take-before-you-hire-a-financial-advisor.html/

    by JoannL — August 29, 2018

  17. JoannL – Just wanted to share that we have had excellent financial advise for FREE from both our Prudential rep. and Thrivent reps. These are both companies where we have life insurance policies and opened small mutual fund accounts many years ago. I like that we use both and have split our investments between them – diversify!?? It also helps to do your own homework but we are now retired from a modest income and relocated to Maine, last Dec (2017). We have been renovating an older home and have had no problems so far! Our future looks good.

    by HollyF — August 30, 2018

  18. Thanks HollyF – we love Maine too! We try to take a vacation there every year. I have a meeting next week with a financial adviser so I will see what he says – compared to the other FA where my IRA is located. I’ve managed my savings myself for years by researching fund sites for ratings and returns/risks. However, when I was younger and working some risk was okay but now I need some guidance.

    I realize it is a business and big money for these FAs, However, I’ve worked too long (40 years) and too hard to turn it over to someone who consults with me 4x year for maybe 15 minutes a call.

    by JoannL — August 31, 2018

  19. JoannL, It may not be for everyone, but check out the Vanguard website. Essentially, the company was established for those like you (and us) who have made (or want to make) the effort to understand investment finance. Read under “Benefits and Costs”, the services that they offer for various levels of investment ($50,000, $500,000, etc.). At those levels they provide good free financial advise from qualified advisors. They also offer continuing paid financial advise if that’s what you want. (The greater your investment level, the more advisor and fund options you have.)

    We’ve been with Vanguard for years, taken their advise and run with it. With that start, their low fees and their excellent fund options (and more lately a bull market) we have near doubled our investments despite our annual withdrawals. It can mean some continued research on your part, but you have the option of accepting the input of their advisors.

    My wife started with Vanguard long before I because her company’s 401K was not “good”. We had compared 401K results for years, mine was always good for us, hers significantly less so, so she transferred to Vanguard, got the free advise and her investments began performing equal to (or better than) my 401K. After comparing for 10 more years, I also finally transferred to Vanguard. An additional unanticipated benefit was that, as a couple, our Vanguard funds in total lifted us to the next level of benefits (more options for advisor sessions and access to funds with even lower fees).

    Good luck to you. I think this is an option that any investor should consider.

    by RichPB — August 31, 2018

  20. We don’t want to pay a percentage of our assets to an advisor so we found one who charges by the hour AND is a Certified Financial Planner (CFP), meaning that person has a fiduciary duty to us (unlike all the other advisers out there without those credentials) and won’t be trying to sell us investments that are not in our best interest.

    Our CFP is also a tax expert, which in retirement is the name of the game. We are extremely pleased with her services. She charges $175 per hour and works in St. Louis.

    Here is the link to the NAPFA, the organization of Certified Financial Planers who charge by the hour with a search tool to (hopefully) find one in your area: https://www.napfa.org/find-an-advisor#tab=filters

    Not every city will have a CFP who charges by the hour. If you are in that situation, I would suggest looking for one in the nearest city and seeing if you can schedule a video appointment. The one we are using takes clients out of town that way.

    by Dave — September 1, 2018

  21. RichPB and Dave – Thank you for your feedback!! I will definitely followup on the resources you listed. RickPB – I was in the same situation as you described for your wife. My soon to be ex-employer initially offered an under performing 401K plan years ago. When they swapped to another plan it has been all about trying to catch up – but hard to do when years were lost to inefficient financial resources. Now I will have an IRA and 401K which I would like to consolidate for simpler management. Thank you again. This site is a wonderful for sharing information.

    by JoannL — September 2, 2018

  22. RichPB and others,
    Does anyone have a suggestion regarding investing in ETF’s vs. Index Funds?
    Thanks!

    by ella — September 2, 2018

  23. Ella – It’s pretty much a wash, if you’re referring to *index* ETFs vs. *index* Funds. If you’re a trader, trade commissions on ETFs (which trade like stocks) might matter, but if you’re a buy/hold investor, it doesn’t matter much. At Schwab, I could sell everything for $5. Fidelity even offers $0 commissions on index products (as a loss leader, I suppose).
    Here’s a link to Motley Fool with a basic explanation of the difference.
    https://www.fool.com/investing/2016/08/26/etf-vs-index-fund-which-is-best-for-you.aspx

    by Peder — September 4, 2018

  24. Has anyone looked into a fixed index annuity as a means of having reliable monthly income in retirement? From what I’ve read about them they seem to require a large lump sum payment to yield relatively small monthly payouts. It seems like there would be better ways to invest that money.

    by Cindy — September 5, 2018

  25. Hey, Ella. I think we both (and most others here at Top Retirements) owe “thanks” to Peder for that Motley Fool link. Previously I could not answer your question other than to say that my minimal investigation of ETFs led me to think that they are more for traders or those “playing” the market. That article confirms that view for me and provides good reason for retirement investors to stick with index funds.

    As we enter RMD time (which my wife and I “achieve” this year), item 3 in the article takes more relevance. We expect that about half of our RMD will be used to cover our typical annual investment withdrawal. The balance will go into a standard (taxable) fund and will thus make item 3 relevant. However, for me, I see no great advantage to changing to ETFs other than possibly the lower entry levels (since these re-invested RMD monies with be fairly low level). But the article also points out the low management fees for Vanguard funds as well as the lower entry levels for those sufficiently invested. Due to our total investment in Vanguard funds at this time, even our relatively low level re-investments will likely be sufficient to meet minimums.

    And those low fees and entry levels are why I think that anyone investing for retirement, should at least consider what Vanguard has to offer.

    by RichPB — September 5, 2018

  26. Just a reminder to everyone that the point of this post was about the 4% withdrawal rate and if it is still relevant. We have digressed into some really interesting discussions about other financial topics. But we also would sure love to hear your opinions about how much to take out of your retirement savings. Thanks

    by Admin — September 5, 2018

  27. Hi Admin – could we possibly open another post to discuss these other related financial topics? These responses are very informative including the links provided even if we have veered a off topic. Thanks!

    Hi JoannL. You are correct, this discussion has been informative, if not exactly on topic. Looking over most of the comments lately, they tend to have been about ETFs vs other options, and using mutual fund companies for financial advice. The closest post we have to that is probably this one, Should You Hire a Financial Advisor, Or Do It Yourself We will move these comments over there and hopefully they will spark even more discussion! Thanks, Admin

    by JoannL — September 6, 2018

  28. With current interest rates being so low, the 4% annual withdrawal guideline has always felt too high to me. The Hybrid RMD mentioned in this very helpful blog post seems like a better option. Clicking on the link brought up the full article as well as the recommended rate of withdrawal from ages 65 through 100.

    My own retirement fund withdrawal strategy aligns pretty closely to their advice. I’ve been taking 3% per annum divided into twelve automatic monthly draws, but keeping aside the interest and increases in principal to fund emergencies and home maintenance projects.

    Thanks for a great article, TR!

    by JCarol — September 8, 2018

  29. Good approach, JCarol. Thanks for sharing a somewhat different option. I agree that today 4% is likely too aggressive. My accounting here may hopefully show others how a similar approach can yield good results — definitely NOT a 4% rule.

    We didn’t do exactly as you suggested but this is not so different. With SS and a small pension to support us, we retired from what had become (for us) unsatisfactory job situations with much less than optimal savings/investments — and with a plan to barely get by should the worst occur. So we set a tight budget, actively monitored it and withdrew only about 1-2% for most of the first 10 years, that has increased with cost and need, but is normally still less than 4%. Fortunately, gains in the market have imprroved our position, but we would have gotten by even without those gains and could still go forward today with our plans for withdrawal — less than 4% for as long as possible. RMD now calls for the same strategy but we will reinvest the “extra” from the RMD. This strategy has enabled us to include a car purchase every 7 years (as budgeted) as well as adding a couple of significant home improvements since retiring.

    Always sticking to and regularly tracking the tight budget, always spending conservatively, always planning conservatively (examples — assume 4% inflation, assume only 6% market gains which we reduced to 4% about 5 years ago) plus decent market returns allow us now at 70 to CONSIDER being more generous in our approach. We paid off our house before retiring (worthwhile sacrifice), we’ve established good budgeting practices to start, we chose to spend the last 10 years traveling the US by car (after some previous cruising and travel to Europe), we have survived some bad health crises, we have not felt severe financial restrictions and at this point are reasonably comfortable going forward.

    ABig help in all this as I’ve posted before is that I created a 40-year budget spreadsheet before deciding to retire that has been constantly updated, improved and modified (call it a hobby with about a week invested every year) which helped with monitoring our status. Not everyone may be able to do that, but my plan is validated regularly using online retirement planners which almost anyone can us, monitor their status, spend with financial conservatism and hope for a good future.

    by RichPB — September 9, 2018

  30. We moved this comment about Phoenix are snowbird rentals to https://www.topretirements.com/blog/real-estate/how-to-find-a-great-snowbird-rental-for-the-winter.html/#comment-309284

    by Brenda — September 10, 2018

  31. The healthy discussion here of retirement account withdrawal rates shows that each individual situation is unique and no hard-and-fast rule will work for everyone. One aspect to be considered is how much of your account you may want to have left when you die. Some people have no children or close heirs and, therefore, may be able to have a higher lifetime withdrawal rate since they don’t need to have much available upon their death for children or others. Of course, they usually don’t want to deplete the account before they die, either. The question of withdrawal rates points out the need to occasionally or regularly consult a reputable fee-for-services financial advisor to help in one’s individual situation.

    by Clyde — September 10, 2018

  32. We moved these comments from a different Blog:

    Bruce – you mentioned the possibility of converting some of your IRAs into Roths. Did you make a decision on that? I’ve been toying with that same thought because our taxable income is likely to increase considerably at 70-1/2 with increased SS and RMDs.
    by JCarol — September 19, 2018

    I have a meeting set with my tax guy in November to see what I should convert. Taxes may never be lower. But I’m also weighing the loss of a senior property tax freeze (must stay under $65K to qualify) and also increased Medicare premiums if I cross $85K. Probably looking at converting $10-20K this year if I want to keep the freeze. Will likely end up in a higher bracket in my 70’s anyway. Now/later, pay/pay…
    by Peder — September 19, 2018

    Can someone explain how the IRA’s into Roth conversion works? Can someone give an example in dollars to show how it works?? by Louise — September 19, 2018

    JCarol….No I have not moved any of our IRA monies into Roth type accounts yet. One reason we have a grandson that is autistic and would set a Roth up for him now and let it grow until he needs it later in his life. Peder also makes a good point about taxes may be more advantageous now then at a later date.?The plan now is two fold we are meeting with an estate planner and our financial advisor to make sure our thinking moving forward is the right path which also includes waiting on taking SS unless we need it.
    by Bruce — September 19, 2018

    Louise – You would contact your IRA trustee and tell them you want to transfer ‘X’ dollars to a Roth (whether with them or another provider). They would do the transfer and would issue a form of the amount transfered to use for tax purposes. The transfer would be considered ordinary income for tax purposes, just like wages. You would pay whatever the tax is on regular income, depending on the tax bracket the extra income would put you in. It would be best to pay the taxes out of non-transferred funds if possible. If you transferred $10,000 and you are in the 12% tax bracket, it would cost you $1,200. But there would be no further taxation once it is in the Roth, since all withdrawals are tax-free. There are no RMDs like there are in a traditional IRA, so if you wish you can leave the entire amount to heirs, tax free. Your heirs need to decide whether to take distributions over their life expectancy or just clear out the account within 5 years. The government does this to get the funds back into the taxable realm. But, sadly, that’s not your problem any more… ?Pay now/pay later, you still pay sometime. The government just lets YOU fret about it while they wait for their cut. ?https://www.marketwatch.com/story/how-the-new-tax-law-creates-a-perfect-storm-for-roth-ira-conversions-2018-03-26?https://www.irahelp.com/slottreport/3-five-year-rules-roth-iras-you-need-know?by Peder — September 19, 2018

    by Admin — September 19, 2018

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