Challenging the 4% Rule

[forrado]

When it comes to the nuts & bolts of do-it-yourself retirement planning the US is where the bulk of the academic research is being done. Which shouldn’t really come as any surprise given that for every 1 UK baby boomer there are 10 in the US.

For decades the 4% rule-of-thumb has been the standard benchmark on which retirement drawdown assumptions have been founded. However, this important central premise is now being challenged within academia as an increasingly unreliable base calculation. Furthermore, North Americans, being the creative race that they are, have been putting forward various flexible replacement solutions.

In a 59-page detailed report released by Morningstar Research (US) on 11th November titled “The State of Retirement Income – Safe Withdrawal Rates” four of these flexible replacement solutions are analysed (see Page 23 of the report accessible via this downloadable link).

Of the 4 methods analysed the one I have adopted for some time is “Method 2” which is based on the annual Required Minimum Distribution (RMD) model applicable to US citizens with qualifying tax-deferred accounts – such as the 401(K) and IRA – being the equivalent to UK employer sponsored DC-type pension schemes and SIPPs. While the UK tax regime does not, unlike the US Internal Revenue Service (IRS), impose similar RMD conditions on its participants, the requirement to factor in remaining life expectancy and annual portfolio account valuations as laid out in the IRS’s Uniform Lifetime Table suits my particular circumstances. My particular circumstances being with no bequest or legacy issues I’m looking for an efficient means to ‘waste’ my asset base with each passing year for my own benefit. To date this is the most suitable approach I've come across that serves my goal.

[JohnW]

In the unlikely even you haven't seen them, plenty to chew on for SWR here: https://www.bogleheads.org/wiki/Safe_withdrawal_rates
And here: https://earlyretirementnow.com/safe-wit ... te-series/

[AsleepInYorkshire]

Is it a rule?

Or is it general guidance for an "average" person?

I'm certainly using it as a projection to give me a clue as to the size of my required pension pot. But I'm also aware that, for me, it's a "rough guide" and there are other variables to consider.

Good luck with your plans

AiY

[Lootman]

Of the 4 methods analysed the one I have adopted for some time is “Method 2” which is based on the annual Required Minimum Distribution (RMD) model applicable to US citizens with qualifying tax-deferred accounts – such as the 401(K) and IRA – being the equivalent to UK employer sponsored DC-type pension schemes and SIPPs.

When I took a look at the minimum distribution rules for IRAs and 401K's I read the RMD as starting at 4.5% at age 72, so a little above the 4% rule that is normally used.

Note that Roth IRAs and Roth 401Ks are exempt from RMDs and, where possible, US retirees defer withdrawing those for as long as possible.

[OLTB]

I’ve found this is an interesting book https://monevator.com/beyond-the-4-rule ... -okusanya/ and have read it a couple of times.

Cheers, OLTB.

[Dod101]

I’ve found this is an interesting book https://monevator.com/beyond-the-4-rule ... -okusanya/ and have read it a couple of times.

Cheers, OLTB.

Thanks. I have not read the book but Monevator articles are usually useful and I found this one to be so. Surely you can circumvent any SWR argument simply by withdrawing the dividends or 'natural income' only? Basically that is what a HYP does, but it is wrapped up in all sorts of strange rules about what you can or should invest in. I have for the last 27 years or so since I retired (early) relied on the natural yield from my portfolio for my income. I have spent a lot of capital over that time but it is clearly capital I could afford to spend since I am better off today than I have ever been in terms of capital and I think income.

forrado appears to be in a different position from me. In any case I would never seek to 'waste' capital for my own benefit or anyone else's because even had I no heirs, I would plan to leave my remaining assets at death to a charity or charities of my choice and I take pleasure in nurturing my assets for that sort of cause.

Dod

[xxd09]

Now 75-many years retired
The Trinity Study on which the 4% withdrawal rate was based was a great guide to me in those far off days especially for a U.K. investor bereft of any sensible financial advice from U.K. sources
Put me on a sound track but that was then
Now I reckon a 3% withdrawal rate would be more realistic which just means you have to save more, cut your costs of investing further and live more frugally
Otherwise the basic premise still stands
xxd09

[dealtn]

Now I reckon a 3% withdrawal rate would be more realistic which just means you have to save more, cut your costs of investing further and live more frugally

Or die sooner?

[1nvest]

In the 1800's you could just buy bonds for a 8% real type reward. Gold and money were the same, exchangeable at a fixed constant rate so it made more sense to hold money deposited into treasury bonds that paid interest as that was like the state fully guaranteeing your deposit and paying you for it to securely store your gold. That all ended in the 1930's, when convertibility was ended. From then on we saw primarily just inflation (currency devaluation) instead of broadly 0% inflation (with considerably interim volatility along the way). Greater prosperity has seen a ever increasing number with surplus wealth looking to preserve/grow purchase power and 8% real yields declined to 4%. Going forward that could very well decline to 2%, excluding tax grabs. Printing money benefits the printer/spender at the cost of devaluation of all other notes, a form of micro-taxation, but when pushed to extremes can become a major taxation. When there is just inflation you have to invest which incurs costs/taxes. We could even see where sufficient common wealth has 0% real (inflation pacing) as 'enough' for many individuals, or even where there is a wealth tax, negative real net total returns, but where individuals having enough wealth can still get by.

[MrFoolish]

How would you factor in a defined benefit pension? Add the transfer value to your assets? Or subtract your yearly pension from your yearly expenditure? Presumably if you have not yet retired, the former method would be easier?

Same question about the state pension. Thanks.

[Lootman]

How would you factor in a defined benefit pension? Add the transfer value to your assets? Or subtract your yearly pension from your yearly expenditure? Presumably if you have not yet retired, the former method would be easier?

Same question about the state pension. Thanks.

If you believe in the 4% rule then the value of a pension is 25 times the amount it pays you annually.

On that basis my state pension will be worth just under a quarter of a million pounds, although that does not reflect the fairly generous triple lock feature.

[DrFfybes]

How would you factor in a defined benefit pension? Add the transfer value to your assets? Or subtract your yearly pension from your yearly expenditure? Presumably if you have not yet retired, the former method would be easier?

Same question about the state pension. Thanks.

We did the latter. University and Local Govt pensions are index linked, as will be State Pension. We're assuming SP will continue to be available. but as we finishe(ed) early then we aren't counting on it and it will probably be for luxuries/ charities / passing down the generations as surplus income.

We aimed for ("spend" - "DB income") x 30 to be comfortable.

Paul

[GeoffF100]

Vanguard's "more flexible approach" is interesting:

https://www.vanguardinvestor.co.uk/arti ... retirement

[TahiPanasDua]

I’ve found this is an interesting book https://monevator.com/beyond-the-4-rule ... -okusanya/ and have read it a couple of times.

Cheers, OLTB.

Thanks. I have not read the book but Monevator articles are usually useful and I found this one to be so. Surely you can circumvent any SWR argument simply by withdrawing the dividends or 'natural income' only? Basically that is what a HYP does, but it is wrapped up in all sorts of strange rules about what you can or should invest in. I have for the last 27 years or so since I retired (early) relied on the natural yield from my portfolio for my income. I have spent a lot of capital over that time but it is clearly capital I could afford to spend since I am better off today than I have ever been in terms of capital and I think income.

forrado appears to be in a different position from me. In any case I would never seek to 'waste' capital for my own benefit or anyone else's because even had I no heirs, I would plan to leave my remaining assets at death to a charity or charities of my choice and I take pleasure in nurturing my assets for that sort of cause.

Dod

Dod,

I feel I could have written an identical comment myself.

TP2

[Lootman]

I’ve found this is an interesting book https://monevator.com/beyond-the-4-rule ... -okusanya/ and have read it a couple of times.

Thanks. I have not read the book but Monevator articles are usually useful and I found this one to be so. Surely you can circumvent any SWR argument simply by withdrawing the dividends or 'natural income' only? Basically that is what a HYP does, but it is wrapped up in all sorts of strange rules about what you can or should invest in. I have for the last 27 years or so since I retired (early) relied on the natural yield from my portfolio for my income. I have spent a lot of capital over that time but it is clearly capital I could afford to spend since I am better off today than I have ever been in terms of capital and I think income.

forrado appears to be in a different position from me. In any case I would never seek to 'waste' capital for my own benefit or anyone else's because even had I no heirs, I would plan to leave my remaining assets at death to a charity or charities of my choice and I take pleasure in nurturing my assets for that sort of cause.

I feel I could have written an identical comment myself.

Obviously it is preferable if you never need to draw down capital to live the way you want. The problem is that that requires a larger pot than if some capital draw down is allowed. And not everyone can achieve that larger pot. So do those people work forever? Or do they use drawdown of capital?

And the danger of trying to live off only the dividends if your pot isn't really large enough is that you will reach for yield in an attempt to finesse the difference, thereby taking more risk.

So living only off dividends is desirable, but that is really saying that a large pot is desirable. It might be better, if possible, but it is not the only option.

[GeoffF100]

And the danger of trying to live off only the dividends if your pot isn't really large enough is that you will reach for yield in an attempt to finesse the difference, thereby taking more risk.

The fans of drawing interest only rarely, if ever, just plan to withdraw the global market dividend of about 1.5%. They invariably reduce their diversification and increase their risk by choosing a higher yielding subset of the shares.

[Dod101]

And the danger of trying to live off only the dividends if your pot isn't really large enough is that you will reach for yield in an attempt to finesse the difference, thereby taking more risk.

The fans of drawing interest only rarely, if ever, just plan to withdraw the global market dividend of about 1.5%. They invariably reduce their diversification and increase their risk by choosing a higher yielding subset of the shares.

And nothing wrong with that. When I retired I had as a primary aim to have enough capital to live off. Inevitably I spent capital in the first few years of retirement, whilst I settled on a strategy (Unlike many here I had very little planning ahead of retirement for all sorts of reasons) Eventually I concluded that buying higher yielding shares would give me the income I needed. I have over the years, modified that and now go for much more modest yielding shares and have long since stopped chasing yield. The natural yield from my portfolio has usually been around 4% or so, currently it would be more like 3.5% which gives me as much income as I need (more than enough actually)

GeoffF100 implies that it is less risky to plan to withdraw only the global market dividend of about 1.5% than to do what most of us do which is 'to choose a higher yielding subset of the shares'. I do not know that that is the case and sounds like some academic theory which just does not hold water in practice. I can vouch for the fact that since the end of 1994 my strategy, such as it is, has worked. Somebody will discover that in the years 1905 to 1914 or some time like that I would have come badly unstuck. Well maybe I would but so what?

Dod

[1nvest]

And the danger of trying to live off only the dividends if your pot isn't really large enough is that you will reach for yield in an attempt to finesse the difference, thereby taking more risk.

The fans of drawing interest only rarely, if ever, just plan to withdraw the global market dividend of about 1.5%. They invariably reduce their diversification and increase their risk by choosing a higher yielding subset of the shares.

The 4% SWR is of course a figure that assumes drawdown. The worst case 30 year outcome that left nothing remaining. Those looking for a PWR - perpetual rate of withdrawal that left at least the same inflation adjusted amount as at the start date, are looking at a much lower percentage figure.

With stocks (global market dividend) providing 1.5%, 30 years of 2.5% in bonds to drawdown and combined provide 4%/year = 25/75 initial stock/bond. Spending down bonds at 2.5%/year assuming inflation pacing and they're all spent after 30 years. Supplemented with dividends and there's your 4%/year. Considered as a linear progression and that will average around 45% stocks, transition from 25/75 to 100/0 stock/bonds as bonds are spent. Rather than such a 'bucket' style others prefer to just constant weight 45/55 (or more commonly rounded to 50/50).

Based on those sorts of figures, 4% is still a reasonable estimate. Whilst bonds may be earning negative real yields at present, at other times they yield positive real yields, broadly washes. The main factors reducing that are taxes/costs, and that the measure was made against a right tail market, US data, that has been a relatively good/great case outcome. For more central/average you might be looking at 3.3% SWR. However even cash deposits that average inflation would see 3.3% withdrawals last 30 years. The other major risk is that of sequence of returns risk (SORR), that tends to be more dangerous in earlier years. If after starting withdrawals your portfolio value halves then then a 4% SWR relative to the start date value rises to being 8% of the ongoing portfolio value. A high weighting to bonds can help reduced SORR i.e. if 25/75 stock/bonds sees stocks halve, bonds remain level then that's a more modest -12.5% portfolio hit compared to a all-stock investor seeing a -50% hit.

A bad SORR for those in drawdown can be good for those still accumulating, enabled new money to be added in at lower share prices. The bucket style (start with 25/75 stock/bond, end with 100/0) will tend to do better than constant weighted (50/50) across a bad SORR period, as that in effect is averaging more into stocks over time, as though also still accumulating. If a strong upward trend follows starting retirement then constant weighted tends to be better, started with more in stocks from the offset.

At recent valuations its looking like the bucket approach is perhaps the better choice at the present time.

Should also be said that in the average case 4% SWR saw multiples of the inflation adjusted start date portfolio value still intact after 30 years. A bucket approach that ends with 100/0 is also a better portfolio for younger heirs to inherit.

[1nvest]

GeoffF100 implies that it is less risky to plan to withdraw only the global market dividend of about 1.5% than to do what most of us do which is 'to choose a higher yielding subset of the shares'. I do not know that that is the case and sounds like some academic theory which just does not hold water in practice. I can vouch for the fact that since the end of 1994 my strategy, such as it is, has worked. Somebody will discover that in the years 1905 to 1914 or some time like that I would have come badly unstuck. Well maybe I would but so what?

If you absolutely must leave a legacy then just spending the dividends will do that, but needs that you worked longer than necessary to build up a much larger portfolio than necessary (or were graced with good fortune of large investment gains or a lottery/inheritance whatever win). And even then doesn't guarantee anything as for instance 1900 to 1920 both stock price and stock dividend values dropped around 75% to leave relatively little.

For many they only want to work as long as necessary and have some years in retirement and the 4% SWR is a GUIDE, suggesting you need 25 times yearly retirement spending saved up in order to fund a average 30 year retirement period. The 4% SWR did however include some cases that fell short, around a 95% chance of success IIRC. So in some cases maybe your money only lasted 25 years, but for 65 year old retirees the odds are against you getting even to age 90.

That bad case outcome risk can be reduced somewhat by relative valuations at the start date. If stocks have made fast/last gains then that can be a indication of over-extension to the upside that might correct and take decades to see those prior highs being reached/breached again. Choose a bucket style (see my prior post) if stocks seem high at the start, or a constant weighted style if stocks seem relatively low or had dipped considerably recently.

[Lootman]

For many they only want to work as long as necessary and have some years in retirement and the 4% SWR is a GUIDE, suggesting you need 25 times yearly retirement spending saved up in order to fund a average 30 year retirement period. The 4% SWR did however include some cases that fell short, around a 95% chance of success IIRC. So in some cases maybe your money only lasted 25 years, but for 65 year old retirees the odds are against you getting even to age 90.

As I understand it the 4% guideline assumes a normal retirement age, so age 66 as at present. If you retire younger that percentage should be lower. But conversely as you get older you can withdraw a higher percentage each year.

At age 90 you can probably safely withdraw 10% a year and not worry too much. Whether you would have anything to spend it on other than nursing care is another matter