Question about Adjusting for Inflation with 4% Rule

[ER Eddie]

This may sound like a dumb question, and I think I already know the answer, but I want to check here to make sure. Sometimes I think I "already know the answer," but it turns out I don't.

This part I understand: When you're using the 4% rule, the amount you are allowed to withdraw is adjusted for inflation each year. I got that.

My question is, when you "adjust for inflation," are you using an average figure (e.g., the average inflation rate over the past 30 years) and adding that same percentage each year, or are you using the then-current rate of inflation (and thus changing the percentage each year)?

I think the correct answer is the former, but I want to make sure. Thanks.

 

[pb4uski]

I think the inflation adjustment is the past year's inflation, so if in the first year inflation was 5% then the second year withdrawal would be 4.2% of the retirement date balance [4% *(1+5%)]. The first year withdrawal would have been 4% of the retirement date balance.

That said, I think very few posters strictly follow the 4% rule.

 

[bingybear]

The 4% rule is unamagical thing if you get a really bad market and lose 50% in a year and next year you only have half as much to spend as you had it before so I don't think that that's a Hold it a call other things come in in life where health or the markets can blow apart your plans so I would try to have more than the 4% that you need is it something else May take it away from you

 

[SecondCor521]

This may sound like a dumb question, and I think I already know the answer, but I want to check here to make sure. Sometimes I think I "already know the answer," but it turns out I don't.

This part I understand: When you're using the 4% rule, the amount you are allowed to withdraw is adjusted for inflation each year. I got that.

My question is, when you "adjust for inflation," are you using an average figure (e.g., the average inflation rate over the past 30 years) and adding that same percentage each year, or are you using the then-current rate of inflation (and thus changing the percentage each year)?

I think the correct answer is the former, but I want to make sure. Thanks.

When FIREcalc runs its simulations, it starts with your FIRE stash and then adds to it each year based on that specific year's market return, then subtracts your spending number adjusted for that specific year's inflation rate. So if you wanted to follow how FIREcalc (and other similar tools) work, you'd do the latter.

But as @pb4uski mentioned, very few if any FIREees actually mechanically follow the 4% rule in that way. Personally I just rerun FIREcalc every so often and make sure my current portfolio/spending/income/longevity works out to 100% historical safety. (Actually, my portfolio has approximately doubled and my spending is approximately flat since FIREing 8 years ago, so now I run FIREcalc to see how much more I "should" be spending.)

 

[ShokWaveRider]

We have not changed a thing and really have not noticed it much with reference to our own Quality of life or expenditure, we are just not saving as much anymore. But we do not need to save anymore either.

Home maintenance seems to be costing more, home painting etc. But then we have not done anything significant for the last 10 years, so it all comes out in the wash. 2023 and 2024 are big home maintenance years for us. Pool Screen Replacement, Tile Roof Maintenance/clean and some exterior painting. I think this is the cost of labour going up though. The trades especially painters are asking a lot more than they were 10 years ago, but that is to be expected.

 

[ER Eddie]

For clarity (OP here), I'm not actually using the 4% rule to determine my withdrawals. I spend what I spend. I just like to know whether I am below the 2% level or not. And in order to know that, I need to know how to "adjust for inflation."

It's just a mathematical question, not a practical one.

I think the inflation adjustment is the past year's inflation.

Ah, okay. Thank you. So this is another case where I thought I knew the answer, but I didn't. The percentage would change year to year.

 

[ShokWaveRider]

After ~15 Years of retirement our WR has been 0 (Zero), in fact the opposite, we have been unknowingly adding to the retirement stash. I am at the point where we need to start spending as we have no heirs other and 3 of our favorite charities. We will make an effort to withdraw ~4% whether we need it or not and hopefully find something to spend it on.

 

[pb4uski]

For clarity (OP here), I'm not actually using the 4% rule to determine my withdrawals. I spend what I spend. I just like to know whether I am below the 2% level or not. And in order to know that, I need to know how to "adjust for inflation."

It's just a mathematical question, not a practical one.



Ah, okay. Thank you. So this is another case where I thought I knew the answer, but I didn't. The percentage would change year to year.

FWIW, Perplexity AI agreed with me.

Here is a concise answer to your question on how the inflation adjustment works under the 4% rule:

The 4% rule states that in the first year of retirement, you can withdraw 4% of your total retirement portfolio. In subsequent years, you adjust this withdrawal amount by the rate of inflation.

For example, if you have a $1 million portfolio, your first year withdrawal would be $40,000 (4% of $1 million). In the second year, if inflation was 2%, you would increase your withdrawal to $40,800 ($40,000 x 1.02). If there was 2% deflation, you would decrease your withdrawal to $39,200 ($40,000 x 0.98).

This inflation adjustment is meant to maintain the purchasing power of your initial 4% withdrawal. The goal is to provide a steady, inflation-adjusted income stream throughout retirement. However, some experts suggest a more flexible, "dynamic" withdrawal approach may be better than strictly adhering to the 4% rule, especially in volatile market conditions.

 

[Chuckanut]

FWIW, I ran Firecalc and a monte-Carlo calculator every year for the first few years of retirement. Things pretty much got better thanks to the booming market. I haven’t run Fire Calc in nearly a year sine the down market of 2022. It’s time for find out if it’s summer lunches at lake front eatery or the food court at Costco.

 

[ER Eddie]

FWIW, Perplexity AI agreed with me.

Very good. Thanks for the confirmation.

 

[ER Eddie]

After ~15 Years of retirement our WR has been 0 (Zero), in fact the opposite, we have been unknowingly adding to the retirement stash.

I guess people calculate withdrawal rate differently. My overall stash is going up, too, but my WR is around 2%. I must be calculating withdrawal rate differently than you are.

I take my average annual expenses, then divide that by the amount I had in my accounts when I retired. The divisor is a fixed figure -- baseline level at retirement. It doesn't change year to year depending on how my overall portfolio is doing. I look at my balance going up, and I'm pleased about that, but that doesn't figure into my WR calculations. That was my understanding of how the 4% rule functioned, but I suppose there are alternative ways to calculate WR.

For me, my withdrawal rate could not be zero unless my expenses were zero.

 

[Dtail]

For clarity (OP here), I'm not actually using the 4% rule to determine my withdrawals. I spend what I spend. I just like to know whether I am below the 2% level or not. And in order to know that, I need to know how to "adjust for inflation."

It's just a mathematical question, not a practical one.



Ah, okay. Thank you. So this is another case where I thought I knew the answer, but I didn't. The percentage would change year to year.

Agree on most recent past years' inflation rate.
If you are just figuring out the concept in order to calculate a current WR, then you would need to add each years' inflation rate since your original retirement date I believe.
For conceptual purposes, it would be more useful to just take your investment assets divided by your withdrawal amount net of any income and compare to the 2% figure.

 

[LateToFIRE]

I guess people calculate withdrawal rate differently. My overall stash is going up, too, but my WR is around 2%. I assume I am calculating withdrawal rate differently than you.

I take my average annual expenses, then divide that by the amount I had in my accounts when I retired. The divisor is a fixed figure -- baseline level at retirement. It doesn't change year to year depending on how my overall portfolio is doing. That was my understanding of how the 4% rule functioned, but maybe there are alternative ways to think about it.

For me, my withdrawal rate could not be zero unless my expenses were zero.

Experts around here will correct me, but I think the way the 4% rule was originally intended, the % WD rate was only relevant in the first year of retirement. 4% of the starting portfolio. After that, % WD rate would be irrelevant as future WD's would be based on the prevailing inflation rate in each subsequent year. Now, that said, nobody seems to actually follow this scheme - but that's my understanding of the concept.

 

[Dtail]

I guess people calculate withdrawal rate differently. My overall stash is going up, too, but my WR is around 2%. I assume I am calculating withdrawal rate differently than you.

I take my average annual expenses, then divide that by the amount I had in my accounts when I retired. The divisor is a fixed figure -- baseline level at retirement. It doesn't change year to year depending on how my overall portfolio is doing. That was my understanding of how the 4% rule functioned, but maybe there are alternative ways to think about it.

For me, my withdrawal rate could not be zero unless my expenses were zero.

IIRC, Shock Wave does not have any equities in his investment assets. So if his assets produce enough income to live on and he never reduces his principal, then the interpretation can be a 0%WR. Can be a similar concept to living off dividend income.
Alternatively, others would state that only if they live off pensions, SS, etc and no withdrawals, then the WR is zero.

As for your above calculation, the numerator for expenses would be net of income suh as pensions/SS.
Alternatively, if one

 

[Dtail]

Experts around here will correct me, but I think the way the 4% rule was originally intended, the % WD rate was only relevant in the first year of retirement. 4% of the starting portfolio. After that, % WD rate would be irrelevant as future WD's would be based on the prevailing inflation rate in each subsequent year. Now, that said, nobody seems to actually follow this scheme - but that's my understanding of the concept.

Not exactly. It would be for example the 4% expenses NET of income for the first year. Then each year subsequently would be adjusted by the most recent inflation rate.
However as mentioned in various threads, almost no one uses this methodology as a withdrawal rate concept, but many use this concept as a guideline as to whether one is in good shape to be able to retire.

 

[ER Eddie]

Others would state that only if they live off pensions, SS, etc and no withdrawals, then the WR is zero.

As for your above calculation, the numerator for expenses would be net of income such as pensions/SS.

Right. I said "annual expenses" to keep the verbiage simple, but a more accurate description would be "the amount I need to withdraw from my investment/savings accounts in order to cover the expenses I still have after my pension covers some of them."

I take your point about having a WR of zero if your pension and SS covered all your expenses. I have a small pension and haven't started drawing SS yet, so I don't fit in that boat, but that makes sense.

 

[LateToFIRE]

Not exactly. It would be for example the 4% expenses NET of income for the first year. Then each year subsequently would be adjusted by the most recent inflation rate.
However as mentioned in various threads, almost no one uses this methodology as a withdrawal rate concept, but many use this concept as a guideline as to whether one is in good shape to be able to retire.

That is what I said. I made reference to "withdrawal" not "expenses". But, thanks for the added detail, Dtail.

 

[Dtail]

That is what I said. I made reference to "withdrawal" not "expenses". But, thanks for the added detail, Dtail.

Haha, okay then.

 

[Al18]

The 4% guideline (it’s not a rule) makes sense when planning for retirement. After you’ve retired two to three years, I would ignore the guideline. Expenses can be lumpy and there’s an excellent chance you’ll still have plenty of money. If you need to replace your roof and your new car in one year, you should not forego other planned expenses such as vacations. Just my opinion.

 

[LateToFIRE]

The 4% guideline (it’s not a rule) makes sense when planning for retirement. After you’ve retired two to three years, I would ignore the guideline. Expenses can be lumpy and there’s an excellent chance you’ll still have plenty of money. If you need to replace your roof and your new car in one year, you should not forego other planned expenses such as vacations. Just my opinion.

This is my operating plan as well. Aiming for a sub 3% WD rate when first 2-3 years of dust settles but not gonna sweat if its a little over the goal post given 4.5% is the new 4%, or is it 4.7% or 3.5% now, I can't keep up.

 

[brett]

We have been retired for 13 years.

Never bothered with the so called 4% rule, never given it any thought.

We base the impact of withdrawals on what our cash flow needs are and what our equity balances are.

I would view it at best as a guideline, certainly not a firm and fast rule.

 

[audreyh1]

I just go by the Dec 31 value each year and don’t inflation adjust. Much simpler. Withdrawal amount varies each year as it is dependent on portfolio performance the prior year and note that the withdrawal can shrink after a bad year. FIREcalc also models this method and calls it % remaining portfolio.

I was more comfortable with this approach compared to the more well known inflation adjusted 4% (or whatever). I don’t need a fixed inflation adjusted amount every year - my spending is highly discretionary and I have a lot of flexibility.

I have used this approach for many years.

 

[RetiredHappy]

We don't restrict our withdrawals. Fidelity shows their Retirement Planning tool outcome at end of planning on the dashboard and you can re-run it as often as you want. It consistently shows that we will end up with a large sum of money. Unless it tells me otherwise, we just continue with how we have been doing it.

After the first 7 years of retirement, we have settled into withdrawing about $100K a year, a mix of taxable and RMD. But each year we seem to always have unplanned lumpy expenses, a new car, home improvement projects etc and we withdraw additional money from taxable accounts.

 

[youbet]

Right. I said "annual expenses" to keep the verbiage simple, but a more accurate description would be "the amount I need to withdraw from my investment/savings accounts in order to cover the expenses I still have after my pension covers some of them."

Actually you're making this way too complicated. Your withdrawal is the amount you take from your FIRE portfolio for whatever reason. If you take the dough out of your FIRE portfolio, it's a withdrawal. Don't worry about what you use the funds for, whether some of your expenses are covered by other income, etc.

 

[ER Eddie]

Actually you're making this way too complicated.

Doesn't seem complicated to me. Seems very simple. (I suppose the verbiage in my post was a little convoluted, but the actual practice is simple.)

Your withdrawal is the amount you take from your FIRE portfolio for whatever reason.

Yes, I understand that. (To be clear, by "portfolio," I mean stocks/bonds/savings).

If you take the dough out of your FIRE portfolio, it's a withdrawal.

Yes, I know.

Don't worry about what you use the funds for, whether some of your expenses are covered by other income, etc.

I'm not worried about what I'm using the funds for. Not sure why you think that.

I was simply saying that some of my expenses are covered by my pension, and some are withdrawn from my stocks/bonds/savings. I calculate WR based on what I pull from the latter. There is nothing complicated about it.