Investing

The 4% Retirement Rule May Be Dead

Austin Smith

Published: June 1, 2024 9:30 am

A recent Schwab (NYSE: SCHW) report questions the longstanding 4% withdrawal rate for retirees, suggesting it may not be suitable for everyone due to changing market dynamics and personal circumstances. Key recommendations include adjusting the withdrawal rate based on current inflation and market performance, considering personalized withdrawal strategies based on additional income sources, and maintaining flexibility to adapt spending. Retirees should consider a withdrawal rate range of 3% to 5%, adjusting annually based on economic conditions and personal financial needs.

Transcript:

Austin, a recent Schwab report questioned the longstanding assumption of a 4% withdrawal rate being safe for retirees.

My question is, we’ve got a lot of retirees out there.

This sounds like big news.

So what do people need to do given this Schwab report?

Yeah, this actually is big news.

So the 4% safe withdrawal rule goes back to a study published in 1994 that states that if you pull down 4% of your portfolio on average per year and you can live off that amount, it’ll be enough to get you to retirement.

But it’s fine on average as a rule of thumb, but it certainly doesn’t apply to everyone.

And things are a lot different today than they were in 1994.

So for one thing, it’s based on a 30-year drawdown timeline, and some people might need more or less than that.

So if you are retiring earlier, obviously, you know that the range of scenarios that can happen to your portfolio widens and that 4% might not be conservative enough.

It’s also based on a 60/40 stock-bond split.

So depending on how your own portfolio is structured, if you have more fixed income, that number might be too high, or if you have more equities and can withstand a little volatility, the number might be too low.

It also assumes no additional income.

So the Schwab report is actually really helpful, and there are three themes that retirees really need to pay attention to.

One is current market dynamics.

In times of high inflation, this report includes that a 4% withdrawal rate could lead to a rapid depletion of funds.

Conversely though, during periods of high market returns or low inflation, retirees might be able to withdraw more than that.

One of the big takeaways here is that that 4% should not be a fixed number.

You need to adjust it based on where inflation is in the current environment that you’re drawing down your portfolio in.

Another is that you need to think about a personalized withdrawal strategy.

So if a retiree has significant income from Social Security or a pension or other work, they might be able to withdraw significantly less from their retirement accounts and still live comfortably.

Additionally, someone with a much longer life expectancy might need to plan for lower annual withdrawals to ensure that their savings last.

Remember that 4% rule is only based on 30 years.

There’s a big range of outcomes that can happen.

So you might need to adjust that number lower earlier in your retirement if you’re retiring early.

And the last one is flexibility and adjustment.

Retirees should remain adaptable.

That 4% number is not fixed.

They should adopt a posture of adjusting their spending as needed.

So, for example, if the market underperforms a year prior, they might want to reduce their discretionary spending on travel or luxury items to get that withdrawal rate down closer to 3% in the next year.

On the other hand, in years where you had really strong market performance, you could actually afford to spend more and could adjust your withdrawal rate up to 5% or even 6% depending on market returns.

So you need to keep a little flexibility there.

Those are the three main takeaways from this report.

What’s the takeaway?

What should retirees actionably do today?

Yeah. So actionably do today.

The 4% rule is great because of its simplicity.

And I don’t think this complicates things a lot, but we really should adjust our math here.

Here’s what retirees should do today: they should adjust to a range of 3% to 5% annual withdrawal rates based on a few factors.

So they should withdraw 3%, 4%, or 5% of their portfolio every year given a few things.

One is high inflation.

If you have high inflation or you have poor market performance the prior year, try a 3% withdrawal rate the next year.

Another is that if you’re an early retiree and you need your portfolio to last longer than 30 years, which is the total range that the 4% rule was built on, start out with a 3% withdrawal rate, get further into retirement, and then as you get closer to that 30 years left in retirement, increase your withdrawal rate to 4%.

Another is that you can go up to 5% if the markets did great the prior year.

If you happen to be on the older side of retirement and you’ve got maybe 15 or 20 years left, you can increase your withdrawal rate to 5% or if you have additional income.

So our new guidance for retirees today is adopt an adaptive strategy of 3%, 4%, or 5% withdrawal rate based on your current situation, additional income, and market performance the prior year.