How Long Will Money Last Using 4 Rule

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 8 minute read

Just how much money do you need to be able to retire comfortably? To what extent may you withdraw money from your retirement fund each year without it becoming depleted? Safe withdrawal rates are the key to understanding both of these queries.

If you don’t save enough, it might be difficult to have a decent retirement. Here is the lesson you never taught in school on how to organize your retirement savings and spending to make sure your money doesn’t leave this mortal coil before you do.

What Is a Safe Withdrawal Rate?

It’s okay if “safe withdrawal rate” is a word you’ve never heard of. The average American has no concept of their retirement savings shortfall, let alone if they are on track to meet their goal.

To put it simply, a safe withdrawal rate is an estimate for how much of one’s retirement savings can be spent each year without fear of depleting the account before one’s death. How much of a yearly withdrawal may you make from a $1,000,000 nest egg, for instance?

The 4% Safe Withdrawal Rule

An expert called William Bengen looked at market data going back decades in order to establish a maximum safe withdrawal rate in 1994. In an essay titled “Determining Withdrawal Rates Using Historical Data,” he first shared his results, which subsequently influenced how people approach saving for old age.

Bengen studied 50 years’ worth of data to determine the effectiveness of a retirement portfolio split 60% to 60% between stocks (following the S&P 500 index) and bonds (in this case, intermediate-term U.S. government bonds). He discovered that retirees may safely take 4.15 percent of their nest egg each year even under the worst 30-year performance scenarios. The original number was 4.15%, but because “the 4.15% rule” didn’t seem quite right, it was adjusted down to “the 4% rule” in following debates.

If you have $1,000,000 saved up, you may safely withdraw $40,000 (or 4% of your nest egg) in your first year of retirement without worrying about running out of money during a 30-year retirement period, according to this rule of thumb.

What about the inflationary pressures?

With inflation taken into account, Bengen’s analysis shows that the 4% rule is only a suggestion for the first year of retirement. A retiree with a $1,000,000 nest fund would withdraw $40,000 in the first year of retirement, $40,800 in the second year, and so on, assuming an annual inflation rate of 2%. This will ensure that their purchasing power does not decrease over time.

Be wary of inflation eroding your Social Security payments if you plan on using them as a mainstay of your retirement budget. According to a research conducted by The Senior Citizens League, the real buying power of Social Security income decreased by 30% between 2000 and 2021, despite the fact that Social Security claims to provide annual cost-of-living adjustments.

Setting a Target Nest Egg Using the 4% Rule

The 4% rule is another method for estimating your eventual retirement income needs. You’ll need a nest egg 25 times larger than your yearly expenditure if you intend to remove 4% of your portfolio each year. The 25x rule is the name given to this consequence.

If you require $40,000 each year to survive, for instance, you need to put away $1,000,000 in savings. 4% x 25% = 100% is easily solved by inverting the formula. Simple enough to perform on the back of a napkin, it will give you a ballpark figure for your retirement savings.

Does the 4% Rule Still Apply in the Current Economy?

However, not every economist accepts the 4% rule, as is the case with just about everything else. An issue that some people have is that bond yields are lower now than they were when Bengen did his research in the 1990s.

However, some who argue that retirees should leave a larger portion of their portfolio in stocks to create higher long-term returns point out that this is always an option. That makes them more susceptible to sequence of returns risk (sequence risk), or the chance of a market drop within the first few years of retirement, which might destroy your nest fund.

The stock market, according to some experts, will perform poorly during the next decade. One of their main points is that just because a 4% yearly withdrawal rate has been OK for the previous century doesn’t indicate it will be fine for the next century.

The dispute comes down to whether or not you are prepared to rely on past investment performance while planning for your retirement. If not, retirement preparations devolve into guesswork and projections. You know that “Past performance is not always predictive of future outcomes” is a disclaimer that has been read a hundred times.

The historical 10% annualized return on the stock market is no guarantee of future performance. But what else can teach us if we can’t learn from the past?

Historical Data Updates

There is some validity to those who question the 4% rule, as Bengen’s studies are now more than 25 years old. Do you think anything has altered in the years since then?

Michael Kitces, an economist and financial planner, has studied the 4% rule in depth. Kitces uses historical data dating back to the 1800s to show that even in the worst 30-year periods, a 4% withdrawal rate with Bengen’s 60% equities and 40% bonds allocation would never have resulted in a nest egg running out of money in less than 30 years.

And that’s not all he says. After 30 years of retirement, most people’s savings have increased, not decreased, in historical circumstances. Kitces demonstrates that pensioners will have greater nest eggs after 30 years of retirement than when they originally retired in 96% of the 30-year periods since 1926, even with a 4.5% withdrawal rate.

That’s one of the main obstacles to saving for retirement. It’s important for retirees to prepare for the worst, even if it means spending far less than they may really need to survive. Do they, though?

How long do you intend to live once you retire?

Professor of retirement planning at The American College Wade Pfau suggests an alternative perspective. Pfau examined comparable data from 1926 and calculated, given a variety of withdrawal rates, the chance that a nest egg would persist for 15, 20, 25, 30, 35, or 40 years. He rebalanced his portfolio between equities and bonds using this method.
Portfolios that were predominantly bonds did worse than those that included at least 50% stocks.

After 30 years, portfolios with 75% equities and 25% bonds with a 4% withdrawal rate had a 98% probability of survival, according to Pfau’s research. In addition, he determined that one had a 93% probability of living for 35 years and a 92% chance of living for 40 years.

What happens if your annual withdrawal rate increases, to 5%, for example? Just 78% of your portfolio will be around in 30 years, 69% in 35 years, and 66% in 40 years.
However, not everyone anticipates residing in retirement for 30–40 years. A 5% withdrawal rate has a perfect track record if you expect to live just 15 years after retirement. Withdrawing at a rate of 6% still leaves a 97% likelihood of having funds for at least 15 years.

The results for a portfolio consisting of 50% equities and 50% bonds are virtually identical in Pfau’s simulations. One hundred percent of these portfolios lasted 30 years, 97 percent lasted 35 years, and 87 percent lasted 40 years at a 4% withdrawal rate. In every 30-year era, and 99 percent of 20-year periods, a portfolio with a 5% withdrawal rate survived at least 15 years.

Practical Advice for Future Retirees

The numbers and statistics are great, but how will they affect your retirement strategy?

  1. Your Safe Withdrawal Rate Will Vary Depending On Your Life Expectancy.

Estimation is necessary for both determining when you want to retire and how long you expect to live afterward. If you’re lucky, you’ll make it to 115. You can’t just decide when you want to retire or how much money you want to remove annually without first calculating your life expectancy.

You may safely remove 6% annually from your portfolio if you expect to live for no more than 15 years after retirement. If you expect to live another 50 years after retirement, you should limit your expenditure to no more than 3.5 percent of your savings.

  1. The earlier you retire, the more adaptable you should be.

Sequence risk, or the risk of withdrawing too much from your portfolio while stock values are low, is most dangerous in the first decade or two after retirement.

How much of a budget wiggle room do you have if the stock market crashes? Rather than liquidating equities, is there any way to reduce expenses? The timing of your retirement might be affected by the market’s volatility. You may protect your savings and weather the initial stock market downturn more easily if you can reduce your expenditure at that time.

  1. Withdraw Less in the Beginning

The longer your retirement nest fund lasts, assuming the stock market doesn’t fall in the first few years, the less of it you should spend each year.

After retirement, you can keep working if you choose to. After you retire, there’s no reason you can’t work a few hours a week or more doing something you enjoy. After I’ve hung up my shingle, I want to spend my time pouring wine at a vineyard. I also hope to spend the rest of my life writing. One of my mom’s jobs is as a tutor. My retired 29-year-old friends Kevin and Ashley Thompson are still active landlords. Take a look at the following list of retirement-era jobs for inspiration.

Concerning the money you’ll need in retirement, you should look into more investments that bring in passive income on a regular basis without having to liquidate any of your holdings. 

Conventional bond investments are available, but high-yield dividend stocks, ETFs, and real estate investment trusts (REITs) are also viable alternatives (REITs). Crowdfunded real estate, P2P loans, annuities, private notes, private equity funds, royalties, and company revenue are all additional asset types.

As retirement time draws closer, it’s a good idea to consider passive income sources that provide little risk. Your retirement savings will grow exponentially over time, giving you the option to take larger withdrawals when you’re older.

Bottom Line

Many people in the United States avoid even considering retirement planning because they find it so overwhelming. That’s a certain way to end yourself once you retire.

Ask yourself, “How much annual income could I live on if I retired today?” to get started. To get a ballpark figure for how much money you’ll need to retire comfortably, multiply that figure by 25.

If you retire at a certain age, you may be eligible for Social Security benefits. The size of your nest egg doesn’t have to be as large if you maximize the money you receive from Social Security. Keep in mind that the safe withdrawal rate will be higher if you retire for a shorter period of time. If you expect to live just 15–20 years after retirement, you can withdraw 5%–6% a year rather than the recommended 3.5%–4%.

Preparing for retirement doesn’t have to be difficult. If you can avoid making these retirement planning blunders and make the most of IRAs and other tax-free retirement funds, you may be pleasantly surprised to find that a 30-, 40-, or 50-year retirement is within reach.

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