Wield Your Retirement Hatchet (and Put the "4% Rule" On the Chopping Block)

Anthony Watson |




  • There's no one "safe" portfolio withdrawal rate in a realistic retirement income plan despite the often cited "4% Rule."
  • Focusing on withdrawal rates ignores the interplay between lifetime portfolio and non-portfolio income, resulting in unnecessary spending sacrifices during the years retirees prefer to spend more -- early retirement.
  • Reality-based retirement income plans recognize that portfolio withdrawal rates tend to decrease over time, allowing retirees to "take more now, and less later," which better aligns with their spending preferences.

The (Obligatory) "Safe" Withdrawal Rate Refresher

Withdrawal Rate % = Annual Portfolio Withdrawals / Portfolio Balance

The concept of a "safe" withdrawal rate was popularized by William Bengen's groundbreaking 1994 study, "Determining Withdrawal Rates Using Historical Data." In a nutshell, Mr. Bengen answered the question: What was the highest withdrawal amount, as a percentage of investment portfolio assets, that would have been sustainable for the worst-case 30-year period going back to 1926? The answer – about 4%, which would have been for a new retiree in 1966.

Since this study and the resulting 4% Rule have been written about ad nauseam, we won't get into the details (but you can here). Instead, the key point we want to emphasize is that even though Mr. Bengen's insights are a giant leap forward for retirement income planning because they show why thoughtfully preparing for "sequence of returns risk" is hugely important, applying a withdrawal rate "rule" doesn't work in reality. (See our Insight entitled "Critical Risk During the "Retirement Red Zone" for more)

It's Not That Simple

Our clients are often in disbelief when they learn how much we believe they can sustainably spend in retirement. We usually trace their reaction to all their reading on safe withdrawal rates and the 4% Rule, which are cemented in the retirement planning lexicon. As a result, their expectations are anchored to the conventional wisdom that says they should only withdraw about 4% of their investment portfolio in any given year, so it comes as a surprise when we encourage them to withdraw 7%.

So, how can a 7% withdrawal rate be sustainable? To answer that question, it helps to look at two assumptions used to arrive at the 4% Rule (this is by no means an exhaustive list):

  • The only source of retirement income is an investment portfolio.
  • Portfolio withdrawals receive an inflation adjustment every year.

We have charted what a hypothetical retiree's cash flow would look like using these assumptions to visualize this.

How does this example compare to your situation? Probably not well if you're like most retirees. In reality, retirement income flows are much messier since retirees typically have a mix of income sources that occur over different periods. Common examples include social security benefits, pensions, and part-time work.

To further muddy the waters, research by David Blanchett CFP®, CFA (Exploring the Retirement Consumption Puzzle) suggests that inflation-adjusted spending actually declines by about 1% per year during retirement, even when accounting for healthcare costs. This change in spending is referred to as "The Retirement Spending Smile" and can be attributed to retirees spending less as they age and slow down, which is in stark contrast to the constant inflation-adjusted withdrawals used to arrive at the 4% Rule.

The Retirement Hatchet

When we chart more realistic income flows and a gradual decrease in spending as our hypothetical retirees, Jim and Kate, get older, the "retirement hatchet" takes shape.

 A Reality-Based Retirement Income Plan:

Wield Your Retirement Hatchet | Thrive Retirement Specialists

What's striking about this example is the 7% withdrawal rate from the investment portfolio in 2023 ($12,000 per month / $2M portfolio = ~7%)! While that may seem like a very high withdrawal rate, you will quickly see that once Jim and Kate begin collecting their social security income a few years into the plan, and assuming they slowly spend less as they get older, the need for portfolio withdrawals (and their withdrawal rate) significantly declines. In fact, their portfolio withdrawal rate drops to about 1% in the last year of the plan.

Armed with this knowledge, Jim and Kate can withdraw more from their portfolio now while they're still energetic enough to live a life filled with adventure and travel, just as they envisioned. Of course, they could decide to stick with conventional wisdom and apply the 4% Rule instead, reducing their portfolio withdrawals (and total income) in 2023 by about $64,000. But, while that may be good news for their heirs, it's an unnecessary sacrifice.

Conventional planning leads to conventional retirements. If you believe you have earned more than convention, click here to schedule an informal, 20-minute call to learn how we can help you make the most of your retirement.