The Infamous 4% Withdrawal Rate

I received yet another article this week, highlighted by an investor website that touted the virtues of the 4% withdrawal rate for fixed income and retired individuals. I scratch my head whenever I see one of these and wonder who is doing the math. A 4% withdrawal rate, or any fixed rate of withdrawal does not take into consideration what I consider to be the most important factor in any withdrawal calculation. We need to cover expenses. If expenses are covered elsewhere, and there are millions invested, then use the 4%... it won't matter. For the rest of us, we need to understand all of the factors and how different approaches work out in the long run. Let me explain using an example...

Let's say my wife and I have $500,000 in investments and savings, I'm retiring next year, and we'll need $70,000 a year for expenses. I have a pension that will pay $2,400 a month, my wife has a pension that will pay $600 a month, and we'll get Social Security at about $650 a month. That gives us $3,650 a month, or $43,800 a year, and leaves us short $26,200. This figure is very important because this is what we need to withdraw annually from our investments and savings.

We know that we'll be getting a return on our investments while we withdraw, but we also know that the return in dollars will decrease as the balance decreases. How long will our money last? Let's run the numbers and take a look at the 4% withdrawal rate scenario first. We assume a 4% return on investment and 2% inflation.

The first thing I notice is that in the first year of withdrawal, we only get $20,000. But we need $26,200. How will we make it? I'm told that applying this rule will guarantee that our money will last. Let's see... so far I'm not feeling very good about this.

It does last. It lasts until I'm 102, but the amount keeps getting smaller. Again, we need $26,200 and this arrangement didn't provide it even in the first year.

If we take the amount we need, it will last until I'm 84 and now I have a data point that I can work with.

Maybe I retire later, or pick up a part time job, but I know the real number now.

At 4% does my money last? Sure does... it just never pays the bills.

Jazer Solutions develops software and solutions for Personal Finance Management. The Personal Finance Navigator which provides a simplified single-source financial analysis and management tool through an interactive tool-set that enables you to analyze, manage, plan, track, and navigate through personal financial information.

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