Interesting article on 4% rule

[Dtail]

I know I've asked this before, but at what point in the year does FireCalc presume you retire? That can make a huge difference.


For instance, on the first trading day of January, 2008, my balance was around $415K. On the last trading day of December 2008, it was around $260K.

On the first trading day of January 2009, I had that ~$260k, but at the end of the year I was around $460K.


BTW, in your example above, if you re-run FireCalc again for the 29 year scenario, I think you need to reset the initial withdrawal back to 3.5%. So it would be $700K for 29 years, which would be $24,500. $35.7K would be 5.1%.

I think the reason the success rate drops off so much is partly the higher initial withdrawal rate, but also, in the 30 year cycle, you just retired going into one of the worst one-year market drops in history. Chances are, you aren't going to do that again in the near future, and the market will most likely recover fairly quickly. But the 29 year cycle starts all over again, and throws in the possibility of you again, retiring into one of the worst downturns in history, but at a higher withdrawal rate, so you're less likely to recover.


At least, that's my rationale. I'm sure there's holes that can be poked in it

IIRC, Firecalc presumes that you retire at the beginning of the year.

 

[foxfirev5]

That's fine. But what did you do when you first retired? If you retired in the middle of the year, you couldn't just wait until the end of the year to take a withdrawal to live on, since you need money to eat, etc. That's what the Bengen study seems to do though. You can retired on $1M at the start of the year, and withdraw $25K at the end of the year. What did you live on during that year?

More specifically I'm not talking about a calendar year. You retire on Day 1, Year 1, which can be any day of the year. Bengen says you can take out 4% at the end of the year, Day 365. In reality, you have to take out or set aside money for year 1 on day 1, not day 365.

Bengen is basically skipping a year of withdrawals. That's cheating. You simply can't live this way. As far as I know Bengen doesn't give a caveat that you set aside your first year of expenses and then withdraw 4% at the end of every year.

I understand your point regarding the "rule". I usually have enough cash to last a few years or to purchase real estate if a no brainer deal comes along. I realize my methods are a bit unorthodox but they've served me well over the years. Actually I don't use a SWR at all. At the end of the year if my total assets are nearly the same or higher I'm fine. Decades of conditioning with incomes ranging from low 5 figures to low 6 figures enables me to weather the storm.

 

[karen1972]

To me it makes sense to reset at some point. I have a 45 year horizon, so the study isn't really applicable and the data set is much smaller.

I run Firecalc every year as part of my yearly financial checkup using the current balance. I calculate using the extension where it shows what 100% WR would be and just track that.

My original # was based on 3.5% WR plus pension, 5 year later, Firecalc says I could take out an extra $8k/yr and still be at 100%. For now its there as a safety net (especially with health insurance); however I am sure at some point if that trend continues I will be adjusting.

Which makes sense to adjust at some point if things go well after all Firecalc shows a range with an upper end in my case of over $20M and an average of leaving $3M on the table. Thats a lot of vacations not taken just in case 100% wasn't actually good enough.

 

[Cessna152]

The one aspect of the 4% rule that has always confused me is this. Lets say I retired last year with $1 M and took out the 40,000. Assume inflation at 3% so next year my WD is $41,200. It's been a good year for the market so the balance has increased to $1.2 M. My Pal who also had $1 M last year (Exactly identical portfolios) Decides to retire this year so he takes his 4% of 1.2 M i.e. $48,000. Why can he take $48K plus inflation and live happily for 30 years while I can only take $41.2 K plus inflation and live happily for only 29 years (since I already used one of the 30). Doesn't make sense to me.

You’ve discovered the “Starting Point Paradox” of the 4% rule - at least that is what Michael Kitces labeled it. He discusses the paradox in this document and a possible rule to adjust for market conditions: https://www.kitces.com/wp-content/uploads/2014/11/Kitces-Report-May-2008.pdf

 

[ejman]

You’ve discovered the “Starting Point Paradox” of the 4% rule - at least that is what Michael Kitces labeled it. He discusses the paradox in this document and a possible rule to adjust for market conditions: https://www.kitces.com/wp-content/uploads/2014/11/Kitces-Report-May-2008.pdf

Thank you so much for the link. Now reading it.

 

[kgtest]

This has been a very, very informative discussion! One of the reason's I love this forum, you all are too smart!

 

[Cessna152]

Thank you so much for the link. Now reading it.

If you liked that, there is a very informative podcast interview with Kitces that you and others might find is well worth the investment of an hour of listening time:

https://www.madfientist.com/michael-kitces-interview/

 

[BeachOrCity]

For some of us who retired early and much of our spend is discretionary (vacations, nice meals out, etc); the 4% rule to start combined with some VPW analysis in later years can be used. All we need to do is cut back in down years. Ratchet up as vpw analysis shows to be ok as portfolio grows is fine.

This also fits nice psychology wise as the desire to cut back in a down market will align with direction given by vpw.

The 4% rule works better for those who need to spend a similar amount each year that is less discretionary.

 

[nancyfrank232]

I didn’t know that the 4% rule is calculated once in the first year and is only increased at the rate of inflation

 

[Dtail]

I didn’t know that the 4% rule is calculated once in the first year and is only increased at the rate of inflation

And thus why in general it is a more valuable tool for retirement ballpark planning vs. an actual withdrawal strategy.

 

[DrRoy]

My first year of RE our WR was 1.8% plus a pension equal to .8%. That let us match our pre-RE spending. The second year was 1.6% (based on the new year end balance) and this year 2.3% (to cover a new deck that has not happened yet). In that time, the investments are up over 18% after the withdrawals. For next year we are throwing caution to the wind and will pull 2.6%. Blow that dough!

 

[Dtail]

For some of us who retired early and much of our spend is discretionary (vacations, nice meals out, etc); the 4% rule to start combined with some VPW analysis in later years can be used. All we need to do is cut back in down years. Ratchet up as vpw analysis shows to be ok as portfolio grows is fine.

This also fits nice psychology wise as the desire to cut back in a down market will align with direction given by vpw.

The 4% rule works better for those who need to spend a similar amount each year that is less discretionary.

It should be noted that the VPW strategy conceptually draws down the portfolio to zero at the end.
Even though the 4% inflation adjusted strategy effectively have the same results, it only achieves those results in the worst of times.

 

[ShokWaveRider]

We/I do not use the 4% Rule. What I do is take our convertible to cash stash and divide it by 30 years + SS. (Overkill as I am 65/6 and DW is 60/1 and my longevity is debatable). As long as it is less than what the stash is returning (Currently 3.5%) I am happy. It is at least 2 x more than we need to want to live VERY comfortably. For big purchases I just take the cash from the stash and re-calculate. We have tried to spend more but our wallet seals shut and we simply cannot .

Even though we do not take our SS yet but DW will be able to next year and I can at any time, we still factor it into the equation.

Hypothetical Example:

$3.75m Divided by 30 = $125k + $42k (SS if an when we take it) = $167k Per Year.

$3.75m x 3.5% = $131.25k. So All Good

 

[nancyfrank232]

And thus why in general it is a more valuable tool for retirement ballpark planning vs. an actual withdrawal strategy.

If a couple has $1m the 4% rule takes out $40k in the first year and subsequent years are increased by the rate of inflation.

Did the article say it was 4% per person or per couple? Does it need to be $80k for a couple?

 

[audreyh1]

If a couple has $1m the 4% rule takes out $40k in the first year and subsequent years are increased by the rate of inflation.

Did the article say it was 4% per person or per couple? Does it need to be $80k for a couple?

Per household. You are comparing against expected expenses. The whole exercise is to see if the portfolio is big enough to support your expected spending in retirement (including income taxes) minus annual income from pensions and SS.

 

[Fermion]

Also the 4% rule may not account for SS if you retire early.

Example us, retired at age ~45. Now at age ~49.

SS even with zeros in the earnings from age 45 to 62 is still a decent amount per month then, something like $2700 a month in today's dollars combined, which is quite a large portion of what we spend per month now.

So in 13 years our SWR could drop from 3.5% down to 2%, or we could increase our spending.

 

[Dtail]

Also the 4% rule may not account for SS if you retire early.

Example us, retired at age ~45. Now at age ~49.

SS even with zeros in the earnings from age 45 to 62 is still a decent amount per month then, something like $2700 a month in today's dollars combined, which is quite a large portion of what we spend per month now.

So in 13 years our SWR could drop from 3.5% down to 2%, or we could increase our spending.

Yes, but that concept is taken into account by retirement calculators using the 4% concept such as Firecalc.
There are definitely folks on this forum including myself who will have some years with spending over 4%, then it drops when SS is taken let's say at 70 y.o.
Firecalc factors the SS and any other income netting against the withdrawals.

 

[Dtail]

If a couple has $1m the 4% rule takes out $40k in the first year and subsequent years are increased by the rate of inflation.

Did the article say it was 4% per person or per couple? Does it need to be $80k for a couple?

In addition to @audreyh1's comment, Firecalc assumes all investment assets are considered as being together, while the income such as SS are listed separately but taken into account together in the overall calculation.
Some other retirement calculators such as I-ORP list all assets separately.

 

[teejayevans]

Also the 4% rule may not account for SS if you retire early.

Example us, retired at age ~45. Now at age ~49.

SS even with zeros in the earnings from age 45 to 62 is still a decent amount per month then, something like $2700 a month in today's dollars combined, which is quite a large portion of what we spend per month now.

So in 13 years our SWR could drop from 3.5% down to 2%, or we could increase our spending.

You can calculate the present value of your SS and add that to you investment balance, then take 4% of the total.

 

[pb4uski]

If a couple has $1m the 4% rule takes out $40k in the first year and subsequent years are increased by the rate of inflation.

Did the article say it was 4% per person or per couple? Does it need to be $80k for a couple?

Same for single or couple since initial year withdrawal is a function of $$$ available at retirement * 4%... so $1 million at retirement would be $40k whether the $1 million is owned by a single or a couple.

 

[zinger1457]

Doesn't that 4% rule go out the door for those with a large % of their assets in tax deferred accounts (IRA, 401K, etc.)? The life expectancy factors used to calculate the RMD changes every year, starts out at about 3.7% at 70.5 but then increases yearly to about 6.5% after 15 years. Those are minimums, one could take more out but not less.

 

[ejman]

Doesn't that 4% rule go out the door for those with a large % of their assets in tax deferred accounts (IRA, 401K, etc.)? The life expectancy factors used to calculate the RMD changes every year, starts out at about 3.7% at 70.5 but then increases yearly to about 6.5% after 15 years. Those are minimums, one could take more out but not less.

Just because the RMD requires the money be taken out of an IRA doesn't mean one has to spend it. I'm taking RMD's (from wife) that we don't need to spend, I just reinvest the funds (after the taxes argh!)

 

[RunningBum]

Doesn't that 4% rule go out the door for those with a large % of their assets in tax deferred accounts (IRA, 401K, etc.)? The life expectancy factors used to calculate the RMD changes every year, starts out at about 3.7% at 70.5 but then increases yearly to about 6.5% after 15 years. Those are minimums, one could take more out but not less.

Just because you have to withdraw from your tax deferred account doesn't mean you have to spend it. You can easily put some of that RMD towards investments in taxable.

 

[corn18]

Yes, but that concept is taken into account by retirement calculators using the 4% concept such as Firecalc.
There are definitely folks on this forum including myself who will have some years with spending over 4%, then it drops when SS is taken let's say at 70 y.o.
Firecalc factors the SS and any other income netting against the withdrawals.

My spending is planned to be 7%-9% WR from 55-70. Then when SS kicks in, it goes to -0.1% (I'm making money). I just need to make it to SS without going completely broke and then I can live forever on my COLA pension and SS.

I stopped using firecalc and use the Flexible Retirement Planner. It is easier to model different scenarios.

 

[zinger1457]

Just because the RMD requires the money be taken out of an IRA doesn't mean one has to spend it. I'm taking RMD's (from wife) that we don't need to spend, I just reinvest the funds (after the taxes argh!)

Yes, good point.