Question about 4% withdrawal rate in retirement

[NYC1967]

Hi everyone,

Question, that might sound stupid but need to ask:

Lets say you have $1,000,000 in retirement accounts. The safe withdrawal rate in retirement is 4% a year (40,000). On average your retirement accounts grow conservatively 4% a year. Its pretty much a wash from what you withdraw a year and earn. How would you ever run out of money?

 

[REWahoo]

Do a little reading about SORR - Sequence of Return Risk.

 

[pb4uski]

Very common question.

First, under the 4% rule the $40,000 withdrawal increases each year for inflation, so if inflation is 3% then the withdrawal in the 10th year is $53,757 [$40,000*(1+3%)^10] and keeps climbing. Second, if at some point early in retirement you have an extended period of negative returns (think 2022's 11.8% YTD return for a 60/40 portfolio) that sequence of negative returns along with withdrawals, can quickly spell financial ruin.

withdrawals taken when the portfolio has temporarily decreased in value permanently inhibit the portfolio's future sustainability objective. This phenomenon is commonly referred to as Sequence of Returns Risk (SORR). The adverse market returns, particularly those that occur early in retirement when balances are largest, coupled with planned withdrawals, can adversely affect retirement success.

4% was the withdrawal rate that survived 95% of the time for 30 years of withdrawals for a 60/40 portfolio... google "Trinity Study"... basically a group of bad case sequence years set a limit on what can be withdrawn and still have money left for that last year withdrawal.

 

[TheWizard]

The point is NOT to run out of money.
And that 4% SWR guideline is just that, a guideline for planning ahead of time.

Lots of folks here withdraw way less than 4%, including me...

 

[NanoSour]

And some draw more than 4% relying on future pensions and social security to significantly cut the draw when that time comes. Just so many ways to skin a cat so to speak.

 

[NYC1967]

OK thanks everyone. Next question when you fill out the firecalc, when it asks for spending, and investments, do you put in total how much you will be spending a year OR how much you will be taking out of your investments per year?

so for example -we want $140,000 to spend a year. We have 1,500,000 saved - BUT will get a total of 50,000 in pensions NO COLA and 49,000 in SS - so will need to withdraw 40,000 per year plus inflation. So do we fill in 140,000 for spending or 40,000?

hope that makes sense.

 

[NYC1967]

And some draw more than 4% relying on future pensions and social security to significantly cut the draw when that time comes. Just so many ways to skin a cat so to speak.

That will be our scenario - for the 1st 7 years we will need to withdraw more, then all the pensions and ss will kick in.

 

[pb4uski]

OK thanks everyone. Next question when you fill out the firecalc, when it asks for spending, and investments, do you put in total how much you will be spending a year OR how much you will be taking out of your investments per year?

so for example -we want $140,000 to spend a year. We have 1,500,000 saved - BUT will get a total of 50,000 in pensions NO COLA and 49,000 in SS - so will need to withdraw 40,000 per year plus inflation. So do we fill in 140,000 for spending or 40,000?

hope that makes sense.

Put in $140k for spending and $1.5m for assets. Then on the Other Income/Spending tab put in each of your SS and your $50k pension and uncheck the inflation adj checkbox and then click on Submit.

 

[pb4uski]

That will be our scenario - for the 1st 7 years we will need to withdraw more, then all the pensions and ss will kick in.

So what FIRECalc will do is to withdraw (spending - SS - pensions) each year based on the information that you provide, and the SS and/or pension reductions for some of the early years would be zero until those income streams start.

 

[NYC1967]

Put in $140k for spending and $1.5m for assets. Then on the Other Income/Spending tab put in each of your SS and your $50k pension and uncheck the inflation adj checkbox and then click on Submit.

OK, thats what I figured. Anyway to add in additional income. For example my husband wants to retire in 2026 BUT I will still working earning income for about 4 years. Where would I put in that $50,000 per year income?

thanks

 

[Rianne]

So what FIRECalc will do is to withdraw (spending - SS - pensions) each year based on the information that you provide, and the SS and/or pension reductions for some of the early years would be zero until those income streams start.

In a bear market, is it better to WD from tIRA accounts earning 3% than from index funds hoping the market improves in the next 5-10 years? In other words, leave the index funds alone if you can survive on the bond/treasury funds for those 5 years.

 

[pb4uski]

OK, thats what I figured. Anyway to add in additional income. For example my husband wants to retire in 2026 BUT I will still working earning income for about 4 years. Where would I put in that $50,000 per year income?

thanks

Well there are a couple ways that you can do it. Probably the easiest is to add $50k annually of "pension income" starting in 2022 and then an entry for $50k annually of off-chart spending starting in 2026... so it will include $50k of income starting in 2022 and $50k of spending in 2026 and from 2026 onwards the two $50k entries will net to zero.

Another way would be to make your spending on the start here page $50k less and than add an off-chart spending item starting in 2026 that is inflation adjusted for $50,000 to reflect that you are no longer working. In theory it should give you similar results, but I think the frist way is better and more intuitive.

 

[pb4uski]

In a bear market, is it better to WD from tIRA accounts earning 3% than from index funds hoping the market improves in the next 5-10 years? In other words, leave the index funds alone if you can survive on the bond/treasury funds for those 5 years.

No right answer, but if you are periodically rebalancing to some target AA in a bear market you would be reducing fixed income... either through skewing where withdrawals come from as you suggest or via a peiodic rebalancing where one sells fixed income and buys equities, depending on how devout to an AA target you are.

 

[GravitySucks]

In a bear market, is it better to WD from tIRA accounts earning 3% than from index funds hoping the market improves in the next 5-10 years? In other words, leave the index funds alone if you can survive on the bond/treasury funds for those 5 years.

Most of my rebalancing is done via withdraws. For over 9 years I've been lucky enough that every withdraw has come from selling equity funds. I will be taking from fixed income for the first time this fall (unless there is a big move this August.).

 

[NYC1967]

Thank you everyone!

 

[Gumby]

Haven't seen it mentioned yet, so I will -- when you input spending into FIRECalc, you must gross up for taxes. For example, if you anticipate actually spending $125k per year, and you are drawing it from a taxable IRA or 401k, you will actually need to draw $160k per year, because you'll be in the federal 22% tax bracket. So, Draw = 160; tax = (0.22 x 160) = ~35; Net to spend = 160 - 35 = 125. If you have state tax, you need to account for that too.

The formula for grossing up is this:

Desired actual spend/ (1 - marginal tax rate). So $125k/(1.00 - 0.22) = $160,256.00 draw from account.

You should use the $160k in FIRECalc, because it is tracking draws on your portfolio, whether that actually goes to taxes or vacation is irrelevant to FIRECalc.

 

[RetiredAt49]

It’s worth noting that Bill Bengen (founder/father of the 4% rule) had already taken SORR into account. He also recently updated his analysis/research and 4.7% is now the “rule/guideline” although in this YouTube video with Rob he goes by into more depth: https://youtu.be/sGs-Slvf-bU

 

[pb4uski]

Haven't seen it mentioned yet, so I will -- when you input spending into FIRECalc, you must gross up for taxes. For example, if you anticipate actually spending $125k per year, and you are drawing it from a taxable IRA or 401k, you will actually need to draw $160k per year, because you'll be in the federal 22% tax bracket. So, Draw = 160; tax = (0.22 x 160) = ~35; Net to spend = 160 - 35 = 125. If you have state tax, you need to account for that too.

The formula for grossing up is this:

Desired actual spend/ (1 - marginal tax rate). So $125k/(1.00 - 0.22) = $160,256.00 draw from account.

You should use the $160k in FIRECalc, because it is tracking draws on your portfolio, whether that actually goes to taxes or vacation is irrelevant to FIRECalc.

No, I would not use that approach. That is a very suboptimal approach and overstates the required withdrawals because only the last chunck of withdrawals is really taxed at 22% and it also ignores the impact of itemized deductions, progressive tax brackets, only a portion of SS is taxable, etc.

A better approach is to use a tax calculator like https://www.irscalculators.com/tax-calculator

If I assume MFJ both over 65 and that all withdrawals are taxable (no preferenced income) then a $141k withdrawal would result in $16k of federal income tax, resulting in $125 left to spend. A lot different from $160k! And using $141k of spending vs $160k of spending would likely result higher different success ratios all else being equal.

 

[TheWizard]

No, I would not use that approach. That is a very suboptimal approach and overstates the required withdrawals because only the last chunck of withdrawals is really taxed at 22% and it also ignores the impact of itemized deductions, progressive tax brackets, only a portion of SS is taxable, etc.

A better approach is to use a tax calculator like https://www.irscalculators.com/tax-calculator

If I assume MFJ both over 65 and that all withdrawals are taxable (no preferenced income) then a $141k withdrawal would result in $16k of federal income tax, resulting in $125 left to spend. A lot different from $160k! And using $141k of spending vs $160k of spending would likely result higher different success ratios all else being equal.

Right.
I couldn't believe that Gumby of all people would use one's tax bracket (marginal rate) as the percentage of gross income going to taxes!

 

[Gumby]

Right.
I couldn't believe that Gumby of all people would use one's tax bracket (marginal rate) as the percentage of gross income going to taxes!

You are correct that you need to account for the 10% and 12% tax brackets. This is definitely a case where my own situation colors my thinking, since I make it to the 22% bracket just on pensions and social security alone, so when I take money from my tIRA, it is ALL taxed at 22%.

The basic principle that I was trying to get across is that you need to include taxes in your spending number in FIRECalc. Calculate them as you want (and in the proper fashion), but you need to account for them.

 

[pb4uski]

You are correct that you need to account for the 10% and 12% tax brackets. This is a case where my own situation colors my thinking, since I make it to the 22% bracket just on pensions and social security alone, so when I take money from my tIRA, it is ALL taxed at 22%.

The basic principle that I was trying to get across is that you need to include taxes in your spending number in FIRECalc. Calculate them as you want, but you need to account for them.

Yes, you definitely need to include taxes in your FIRECalc spending number. Since we do Roth conversions to the top of the 12% tax bracket, our taxes are pretty stable so I just include $x thousand on top of our annual spending target to provide for taxes... it's about 10% of our total spending.

 

[NYC1967]

Its funny how when we met with a financial planner (yes I know they want us to invest with them because they get like a 1% fee) anyway, they told us my husband could retire today and we would be more than good. I know better, since I'm a boglehead investor. On the firecalc calculator we are not even 100% ready for my husband to retire in 4 years like he really wants to (he would be 60). He so wants to believe the financial planner is correct. He is not into investing and researching like me.

I assume we want to see 100% success rate on the firecalc?

 

[youbet]

I assume we want to see 100% success rate on the firecalc?

No need to "assume" anything. You decide. But do your best to understand FireCalc back-testing and the statistics behind it. Choosing 100% may increase the length of time you need to continue working while providing only a small reduction in risk. And conversely, choosing a smaller percentage success rate increases your risk while possibly allowing you to retire sooner.

Keep in mind that there is great variability in outcomes and there are many determinants over which you'll have no or little control.

That's what makes it fun! I'm 17 years into full FIRE and still wondering how it's all going to work out financially....... Although, so far, so good!

 

[GravitySucks]

Its funny

I assume we want to see 100% success rate on the firecalc?

That's a personal decision. I retired with a much lower score than 100% in Firecalc, some here waited till they were 100% then keep working and saving.

 

[NYC1967]

That's a personal decision. I retired with a much lower score than 100% in Firecalc, some here waited till they were 100% then keep working and saving.

Do you worry you won't have enough?