The 4% withdrawal "rule"

[medved]

When people talk about the "safe withdrawal" rate (or the so-called 4% rule), does the spending include ordinary income taxes? Capital gains taxes? Advisor (or investment management) fees?

 

[MissMolly]

It includes all spending, regardless of the reason for the spending.

 

[Gumby]

Yes, everything. If you use FIRECalc, you must gross up your spending number on the first tab to account for taxes.

 

[medved]

Yes, everything. If you use FIRECalc, you must gross up your spending number on the first tab to account for taxes.

I was afraid of that. Without spending a lot of time on it, or asking my advisors to do that, I really do not have any idea what my taxes are likely to be in each year -- even under current tax rates -- and those rates will probably change anyway. (To be honest, I don't really even know what my spending will be -- but that is a different issue).

For FIRECalc purposes, I took what I think our spending will be -- my best guess -- and then I multiplied it by 250%, which is my lame and I suspect very conservative effort to account for advisory fees (30-35 bps), taxes, and the chance that my spending might be more than I am guessing it will be. FIRECalc still spit out a 100% chance of success, so I should be OK. I suppose I will have better estimates after my first year of retirement. (I am retiring end of this year).

 

[Focus]

You might have a little more to play with. From CNN:

"Recognizing the criticisms and noting how market performance and inflation have changed over time, Bengen has revisited the rule. In a 2021 article for Advisor Perspectives, Bengen said a 4.7% withdrawal rate would be safe.

"Then, in 2022, given the uncertainty over inflation and bond prices at the time, he told financial news website ThinkAdvisor that 'if people want to take a few tenths off 4.7% and take it down to 4.5% or even 4.4%, I wouldn’t argue.'"

That said, nearly 10 years into retirement, I've found the rule to be little more than a reference point. My costs have varied wildly year to year due to unexpected major expenses.

 

[RetiredHappy]

I just build my own Excel spreadsheet/workbook to figure out expenses, withdrawals, income stream, tax bracket which is derived from income streams and withdrawals, capital gains etc. I don't bother with withdrawal rate. Using withdrawal rate is backwards for us. Our expenses drive withdrawals. Early on in retirement, our withdrawal rate was probably about 8%, new home and home projects drives higher withdrawals, and when all of our income streams kick in, our withdrawals are going to be closer to 2%.

 

[Dtail]

The 4% guidance WR is probably best applied with calculating if one is in reasonable shape to retire. Very rarely is it used as an actual WR percentage consistently each year.

 

[mrfeh]

First step is to get a better handle on your expenses. It's impossible to plan for the future if you don't know what they are.

Of course, you can't know exactly what your expenses will be in 5, 10, 15 years, but you need to know what they are now, and for the next couple years, to use as a baseline. Don't forget to include lumpy expenses (ie. you may not need to buy a car in the next couple years, but you will at some point).

 

[audreyh1]

When people talk about the "safe withdrawal" rate (or the so-called 4% rule), does the spending include ordinary income taxes? Capital gains taxes? Advisor (or investment management) fees?

Taxes are considered expenses, so yes they have to be included in the spending part of the equation.

 

[medved]

First step is to get a better handle on your expenses. It's impossible to plan for the future if you don't know what they are.

You are right, we need to do that. But we never have. I had a relatively high income, so we had the luxury of spending whatever we wanted without keeping track of it.

In my first year of retirement, 2025, I think I will fund my checking account with an amount that should be more than my expenses for the year. And then pay everything from the checking account. Then, at the end of the year, I will be able to tell what my expenses were for that year. I’m not really sure how else to do this.

Even that is not perfect, since I think our expenses will vary pretty substantially from year to year. But at least it’s something to start with.

 

[TheWizard]

You are right, we need to do that. But we never have. I had a relatively high income, so we had the luxury of spending whatever we wanted without keeping track of it.

In my first year of retirement, 2025, I think I will fund my checking account with an amount that should be more than my expenses for the year. And then pay everything from the checking account. Then, at the end of the year, I will be able to tell what my expenses were for that year. I’m not really sure how else to do this.

Even that is not perfect, since I think our expenses will vary pretty substantially from year to year. But at least it’s something to start with.

Usual way of analyzing expenses is to partition them into maybe three categories.

#1 is basic expenses, which includes food, restaurant meals, clothing, insurances, property taxes, utility bills, fuel, subscriptions, memberships, and other things that repeat month after month.

#2 is infrequent but predictable expenses such as new car every 6-10 years, new appliances every 10+ years, new roof as needed, etc

#3 is discretionary expenses, often travel or recreational things. Probably should also include buying a new boat or RV if that's your plan.

Then you can compute your Desired Retirement Income, starting with #1 + #2 (annualized somehow).
To that, add a more or less hefty sum for #3 depending on your lifestyle expectations and your finances...

 

[Lewis Clark]

As a first pass, you can total the withdrawals from your accounts from each monthly statement. Checks, electronic bill pay, cash withdrawals. This is a quick way to get monthly and annual totals, though not by category. Do this going back for several years. This will give you a good idea what you typically spend.

Then add an annual amount to account for lumpy expenses such as new vehicles, roof, hvac. And so on.

If the annual total spend results in a comfortable withdrawal rate you don't need to worry too much about the details for now. Though it is a good idea to know how much spending is discretionary.

 

[audreyh1]

Some of us had been tracking expenses for years using software like Quicken. This made it very easy for me to estimate future expenses. I certainly looked at recent expense history of a few years and reviewed how our spending might change. Overall this gave me a lot of confidence about future projections.

 

[TickTock]

In my first year of retirement, 2025, I think I will fund my checking account with an amount that should be more than my expenses for the year. And then pay everything from the checking account. Then, at the end of the year, I will be able to tell what my expenses were for that year. I’m not really sure how else to do this.

Even that is not perfect, since I think our expenses will vary pretty substantially from year to year. But at least it’s something to start with.

We've tracked monthly expenses (other than federal and state taxes) since 2008 with a spreadsheet; one tab per month. Most expenses fall under our credit cards. Occasionally we write checks or pull some $$ from an ATM. There's usually only ~6 entries per month. It's not much trouble for us to track.

 

[walkinwood]

It is quite easy to get a high level view of your spending. Just look at what your deposits and withdrawals from your main checking accounts. And then subtract what you've transferred to your investment accounts (if anything). It is a good start.

Taxes will probably drop in retirement. Buy a current copy of Turbotax and enter your information there, using your last year's tax returns & zero out your earned income & any contributions to tax deferred accounts. Again - a good first approximation

However, if increasing your spending by 250% still leaves you with a 100% success rate, maybe you should be doing something more fun with your time.

 

[TheWizard]

One small point. The OP mentions investment management fees as an expense. It is, but I think most people don't put AUM fees down as an expense on their spreadsheet.
Rather, they just consider it a higher Expense Ratio on the funds they own.

So instead of getting 20.0% total return on your index fund last year, you got 19.7%...

 

[Gumby]

That's the way I look at it. When I'm toting up my mutual fund assets, I just use the NAV, which is net of the 12b-1 fees.

 

[Willers]

Some of us had been tracking expenses for years using software like Quicken. This made it very easy for me to estimate future expenses. I certainly looked at recent expense history of a few years and reviewed how our spending might change. Overall this gave me a lot of confidence about future projections.

+1 Estimating expenses was pretty simple for us because of our Quicken history. It also clearly reminded us of how lumpy expenses can be.

If you haven't tracked, start doing so in Quicken, a spreadsheet or something else and you'll see where expense might change in retirement. Our total was relatively predictable, but the category spending changed significantly.

 

[pacergal]

Start tracking expenses now, at least you will have 4 months until the end of the year for a quick eyeball.
There are several budget trackers available or create your own, whatever you are comfortable with.
Separate the Needs, from the Wants.

 

[RamStride]

[...] If you use FIRECalc, you must gross up your spending [...] to account for taxes.

I just started playing with FIRECalc today. What do you mean by 'gross up'? Do you mean multiplying by your tax bracket and adding that amount to the the total?

 

[Dtail]

I just started playing with FIRECalc today. What do you mean by 'gross up'? Do you mean multiplying by your tax bracket and adding that amount to the the total?

For example it means that if your expenses are 100k without taxes and your taxes are 15k, then you must gross up your 100k expenses by the 15k of taxes.
Thus your input gross number would be 115k.

 

[Gumby]

I just started playing with FIRECalc today. What do you mean by 'gross up'? Do you mean multiplying by your tax bracket and adding that amount to the the total?

In FIRECalc, "spending" means ALL spending, including all income taxes. So, for example, let's say you expect to spend about $100,000 on everything but income tax, and all of your spending will be paid for by taking money out of your traditional IRA. That withdrawal is ordinary income. If you are married filing jointly, with $100k in fully taxable ordinary income and you use the $30,000 standard deduction, in 2025 you will have a taxable income of $70,000, which means you'll be in the 12% marginal bracket.

However, you can't just take $100,000 out of your tIRA and then spend it on all your other stuff, because you need to pay the income taxes on it. At $70k taxable income, you will need to pay the following: 10% on the first $23,850 plus 12% of the amount over $23,850 (but under $96,950 - where the 22% bracket starts)

So: (23,850 x .10) + ((70,000 - 23850) x .12) = $7923 in federal income tax, which must be paid on top of your $100,000 in spending on everything else. So you need to take $100k plus $7923 out of your IRA

BUT WAIT, that's not all, because the additional $7923 that you took out to cover the tax on the $100k is in itself taxable income on which you must pay tax at 12%. So you need to "gross up" to include the tax on it as well.

The formula for grossing up is this:

X = amount you need to net to cover your existing tax obligation (here $7923)
Y = Gross amount you actually need to draw from your IRA
R = marginal rate of taxation (here 12% or 0.12)

Y = x/(1-R) >>> Y = 7923 (1-0.12) = 7923/0.88 = $9003

So you will need to draw $109,003 from your tIRA. Of that, you will pay $9003 in income tax and will spend $100,000 on everything else. And the number you put in "Spending" on the "Start Here" tab of FIRECalc is $109,003.

Also, don't neglect state taxes, if applicable in your state.

 

[RamStride]

For example it means that if your expenses are 100k without taxes and your taxes are 15k, then you must gross up your 100k expenses by the 15k of taxes.
Thus your input gross number would be 115k.

In FIRECalc, "spending" means ALL spending, including all income taxes. So, for example, let's say you expect to spend about $100,000 on everything but income tax, and all of your spending will be paid for by taking money out of your traditional IRA. That withdrawal is ordinary income.

Ah, makes sense. I was understanding the 'Spending' box in a different way. I was using the total of my current spending bills. I overlooked the additional cash I may take from the taxable accounts. Noted! Thanks to both of you.

 

[brett]

I have never used firecalc. Nor have I ever used quicken. I had enough of spreadsheets and margin calculations during my career. All of our calculations, pre retirement and post retirement, were based on after tax dollars.

Instead, I tracked after tax spend. At a macro level. I have never have subscribed to the 4 percent rule, or any percent rule. Zero percentage in following this to the letter. Let common sense prevail along with some very basic math.

From my perspective it will always depend on ROI, and the change in equity balances YoY.

For us, it is all about the gap. The gap between guananteed cash flows, spend, ROI on investments, and equity balances. Net of tax, net of inflation.

 

[equakesfan]

I estimated my spending going back in time by taking the change in my bank account balance and subtracting out income and transfers. (i.e. My starting balance was $20,000, There was $10,000 in income, I transferred out $1000, I transferred in $2000, My ending balance was $22,000, My spending was $7000 {20,000+10,000+1,000-2,000-22,000=7000}. I ignored taxes because for me it didn't make much difference. (My estimated taxes paid were close to the actual taxes.)