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The 4% Retirement Withdrawal Rule



How many of you have heard about the 4% retirement rule? I suspect that those who have looked into retirement have come across this rule in one way or another.

What is the 4% rule?

The 4% rule is the percentage of your portfolio that you can withdraw / year while keeping the balance intact. This is assuming that you stay invested in the market with balanced asset allocation.  According to William Bengen, CFP, 4% of your portfolio can be withdrawn from your portfolio (adjusted for inflation) while keeping your portfolio intact for 30 years with extremely high certainty.  This is assuming a 50/50 equities/bond asset mix during retirement.

Some Examples:

  • If I grew my portfolio to $1,000,000 by the time I retire, I can withdraw $ 1,000,000 x 4% = $40,000 / year until I draw my last breath. This will keep most/all of the capital intact to pass onto my heirs/beneficiaries.
  • Trying to figure out your portfolio value required for a certain lifestyle? If you needed $50k/year to survive during retirement, according to the 4% rule, you would need $50,000/4% = $1,250,000 in portfolio value.

My Scenario:

If i decide to retire early and live entirely on my portfolio, I would need a considerable portfolio size if I wanted to follow the 4% rule.

From my Retiring Early Series, I determined that we would need around $45,000 / year to live comfortably (in todays dollars). If we retire before CPP/pension benefits kick in, we would need to depend on a portfolio size of $45,000/4% = $1,125,000. Looks like we have a little ways to go. :)





34 Comments, Comment or Ping

  1. 1. Mike

    Interesting, I’ve been thinking about this topic the last little while.

    Some good articles on the topic: http://www.bylo.org/saferetr.html

  2. 2. Mike

    One thing I’ve been trying analyze is the effect of future income flows on the amount you can safely withdraw. For example, the studies that conclude you can take 4% out assume that you are taking steady withdrawals out each year. 4% in year 1, and then take that same amount plus inflation out each year after that. However what happens if you will be receiving other pensions (cpp, oas) in the future. In my case if I retire at 55 then we will be getting cpp & oas at various times in the future and those amounts should end up being about 40% of our required income. My theory is that we should be able to take a bit more than 4% (4.5? 5.0?) since we will only be living completely off the rrsp for the first 5 years.

    Another big factor which I’ve read about is flexibility. Some of the articles I’ve read talk about withdrawing more after a good year (in terms of return) and less after a bad year. The worst case scenario is a bad bear market right after you retire which would mean either cutting back or better – just go back to work for a couple of years. William Berstein has some interesting articles (in the above link) where he looks at some of the worst case scenarios that have actually happened in the last century. Sometimes it boils down to luck of the draw.

  3. Just a clarification: the 4% rule assumes that a bit of the capital will be depleted and applies to someone who is retiring at the traditional age, not to someone who is retiring early.

  4. CC: What is the age of the retirement assumed with the 4% rule? Do you have any studies that show the earliest you can retire with this rule?

  5. 5. Mike

    The studies I’ve read usually have a maximum retirement of 30 or 35 years although maybe some of them are higher – I’ll have to go back and check. So if you retire at 55 and assume you’ll live to 95, that’s 40 years which isn’t that much longer than the studies. I remember Berstein talking about assuming a never-ending retirement for a long retirement since it’s the same thing.

    One of the big lessons I’ve learned is that there is a lot of variance in what can happen in the future and planning only covers so much. I don’t even know if it’s worth trying to figure out if you should be withdrawing 3.74% or 4.12% in that first year since that decision can so easily be overshadowed by other events. Low returns, high returns, inflation, health, spending changes – there are so many things that can alter your retirement for better or worse. I think you should plan as best as you can for retirement but then flexibility is probably the biggest tool you have once you are retired. I also don’t think it’s necessarily worth it to be “too safe” either since the only way to have a risk-free retirement is to keep working.

    One more point (apol for long comment) – every single study I’ve seen has been based on historical returns generally using US data from 1922 onwards. This period was a pretty good one for the long term investor as far as equities are concerned (with a few exceptions). In fact Berstein points out that the US market was the best performing market in the 20th century so basing all these studies on that data might paint a better picture than what might actually happen in the future.

    Bottom line is that although I think the 4% rule is a good one to follow – it’s still a generalization so you shouldn’t take it as gospel.

  6. I’ll agree with Mike. The 4% thumb rule is from a study (forget which, you’ll have to look up The Number book) which ran a Monte Carlo simulation for someone retiring at 65 and looked at (I am trying to remember here, so don’t kill me if I am wrong) a 90% probability of not running out of money. So, even with the 4% rule, in the worst case scenario, you could run out of money.

  7. The 4% rule has been endlessly debated on some forums. Check out:

    http://www.early-retirement.org/forums/index.php

    And do a search for “4% rule”. You will see ever study ever done on the topic and some serious debate about it.

    The general idea that most people have is 4% is the average value. You can take more if you are willing to take an increased risk. In Mike’s case I would suggest you can easily push 5% or higher for those first five years.

    CD

  8. Seems that I have started a popular topic among the big hitters in the blog world! :)

  9. 9. Cannon_fodder

    If you think a la Derek Foster, wouldn’t you simply set up a portfolio that pays about 4% dividend income? Assuming it isn’t in an RRSP, it would be relatively tax efficient and, assuming the portfolio grows faster than inflation, protect your income going forward. In theory, one might not have to touch the principal at all.

  10. 10. Mike

    Cannon_fodder – I’ll agree with your statement except for the use of the word “simply”.

    The other problem is that if you are in a high tax bracket it doesn’t make sense (to me) to not use the rrsp.

  11. Having earned my living as a Civil Engineer I was always very aware about the inherent uncertainty of forecasting future events.

    I built a number of safety factors into my retirement cash flow predictions. For my investments outside pension plans, I estimated only a 3 % investment return before taxes, trying to cover myself for the bad years.

  12. 300 is broken! Congrats FT! :)

  13. Long term resistance @ 300 has been broken, keep watching for higher highs. ;)

  14. 14. Cannon_fodder

    Mike – I didn’t mean to imply that you wouldn’t use an RRSP just that the treatment of dividend income would be advantageous if it didn’t come from an RRSP.

  15. 15. Nicolas Roy

    I believe this 4% should never be considered as a rule. It’s a statistic and should only be considered as is.

    On a case by case basis it has limited value.
    As CD said, it all depends on you: the risks you take and the way you invest.

    After all what is you current return vs the average investor?

  16. 16. Cannon_fodder

    Looking through my RRSP it is easy, and relatively predictable, to estimate dividends produced from stocks I own. Looking at the equity mutual funds much less so.
    Some of my funds issue income dividends, capital gains, neither or both.
    If I were trying to compile an overall portfolio view of how much dividend income it produces, would I include the mutual fund dividend income and capital gains? Would the only thing I not include be any return of capital?

  17. 17. Mike

    CF – are you referring to the 4% rule? or the Derek Foster method?

    I can tell you the 4% rule applies to withdrawals from the investment pool – doesn’t matter what form it’s in.

    From what I’ve read of DF’s strategy, any dividends will represent your income regardless if it’s interest, dividend, cap gain, roc. I think some of the higher paying income trusts were including large amounts of ROC in their payouts which is tax efficient method of withdrawal of principal (no cap gain) but I’d be wary of investing in too many companies that are paying out more than they can earn.

    I’m not sure if I understood your question so feel free to correct!

  18. 18. Cannon_fodder

    Mike – I just want to be sure I’m not fooling myself by considering the capital gains and dividend income from a mutual fund as, in fact, income. It is different from a stock in that, if you have the income reinvested, the total value of your holdings doesn’t change – the number of shares you own goes up by an amount that the NAVPS goes down to balance out. With a stock, it is not quite that simple – it’s price after the ex-dividend date could be higher, lower or even the same.
    If my goal is to amass a portfolio that pays out enough income (and I’ll exclude ROC) that provides enough for my wife and I in retirement, I had previously only looked at stocks and not my mutual funds (since I don’t have any ‘income’ type mutual funds) as part of the equation. I believe now I should include mutual funds as well.

  19. 20. Mike

    CF – I see what you mean.

    I’m no expert on the DF strategy but I would think the dividends from mutual funds should count as well.
    However, if you are doing the DF strategy then any mutual funds or ETFs that you buy would be dividend stock focused and would hopefully only pay out “dividend” dividends vs interest income, ROC etc. So if you have non-dividend focused funds / ETFs now then I would say their dividend payout might be somewhat irrelevant to what you are planning to do since you will probably switch them to something that pays out more dividends.

  20. 24. Ed Rempel

    What assumptions do you use for the 4% rule? Assuming conservative assumptions, with 3% inflation and 40 years, the 4% rule needs 5.7% return on the investments for the money to last 40 years.

    This is an interesting topic. We do the retirement plan custom for everyone, so I had never actually worked out a rule of thumb. If we assume a long term average return of 8% and 3% inflation, we can withdraw 5.5% each year (plus inflation) for 40 years.

    Perhaps it should be a 5.5% rule?

    A couple of income comments. Dividends may be quite tax-efficient but are less so for retirees, since they are subject to many clawbacks, such as the GIS, the age amount and OAS. Most of their income at different ranges is clawed back at least 15% in addition to regular income tax.

    With the new tax rules, the 45% gross-up on dividends means $10,000 in dividends will show as $14,500 of income, on which the clawback will be $2,175.

    In effect, there is a 22% clawback on most dividend income for retirees in addition to regular income tax.

    As for income trusts or funds paying a mainly ROC distribution, these are mostly non-taxed income and not subject to clawbacks. However, this is mostly an illusion. There is actually hardly any difference between just selling a bit of your equity investment each month and receiving the ROC distributions.

    You can do a SWP (systematic withdrawal plan) and much of the money is a return of your capital (depending on how much capital gain has built up over the years). The differences between a SWP and a distribution that is mainly ROC are mostly technical.

    However, a SWP can be done effectively on any equity investment, not just the short list of those that pay distributions. This means you don’t need to buy an “income” type mutual fund to get good regular income.

    Ed

  21. The 4% rule is basically the amount that can be withdrawn from your retirement account per year “indefinitely” providing that the money is invested. It’s a general rule of thumb that I picked up reading around the financial boards. It’s definitely a VERY rough estimate, as you have shown.

    Great comment by the way.

  22. 26. Ed Rempel

    Hi FT,

    Maybe the difference is whether or not you use up the principal. The 5.5% rule assumes you use up the principal over 40 years. That is close to indefinite, but not quite the same. If you assume you only use the profits, then a 4% rule possibly assumes a 7% return and 3% inflation.

    We would normally assume a conservative 8% return, so with 3% inflation, that would be a 5% rule (instead of a 5.5% rule that uses up the prinical).

    Ed

  23. 27. Mike

    Ed, there are some great articles at the link below which talk about the 4% rule.

    Basically they assume you are using your capital but the probabilities they come up with are based on using Monte Carlo simulations using US stock returns and inflation over the last 85 years or so.

    It’s more of a guideline or starting point than a solid “rule”.

    http://www.bylo.org/saferetr.html

  24. Why would you want to have the $1,000,000 intact when you die? Let the life insurance make the kids happy and have fun with the rest!

  25. Hey this is very interesting. I was a finance major in college – but I don’t remember learning about the 4% rule for retirement. Would anyone have a peer reviewed article on this to recommend to me? Thanks!

  26. Ms Save Money, the 4% rule is a pretty common rule among retirement planners. Even BMO Chief Economist, Sherry Cooper, uses it in her book The New Retirement.

  27. 33. Sid Edwards Pensioner

    The 4% rule means that you can have a 30-40 yr life of retirement. The rules
    covering RRIF’s with the increase from 5% up to 20% per year means that by 90 yrs of age you are out of money.The only way around this is that you have an equal amount in registered and non registered accounts. With many people
    expected to live to be 100yrs. or more there will be a lot of people living a very
    meagre life unless they have a lot of money or a well funded DB plan or be an
    ex Govt. employee.The fact that RRISP’s or RRIF’s do not get any assistance
    from the dividend tax credit that DB’s get.This means that I am not as good as a Government employee or amember of a DB or Insurance Company.
    If these problems are not addressed in the near future we will have quite a mess on our hands Pensioner

  28. 34. Neil Hampshire

    If you follow Robert Prechter’s Elliott Wave theory, 4% rule would not work since we are in a bear market supercycle, and we are heading back down to Dow 4000 at the very least and may even go as far as Dow 1000. It would be best to have all your money in US Treasuries at 4%. We are going through a Japanese style deflation and will be best to have zero equities.

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