Should You Use a 'Safe' Withdrawal Rate?

It is widely acknowledged that a “safe” withdrawal rate is in the 4% range, meaning that if you retire with $3 million, you can spend about $120,000 a year, adjusted up each year with inflation, and expect your money to last 30 years with a very high level of confidence. While there are no guarantees in life, this is considered to be safe. This data was first demonstrated to the masses with the Trinity Study back in the 1990s. If you've never seen this table, spend some time with it so you'll understand this discussion and others like it.

Using historical data and a 50/50 portfolio, a theoretical retiree spending 4% (adjusted upward with inflation each year) only ran out of money 4% of the time. At 5% of spending, that climbs to a failure rate 1/3 of the time, and at 6%, that climbs to 1/2 of the time. That's why 4% is considered a safe withdrawal rate (SWR) and 5%-6%, much less the 8% advisors were telling their clients in the 1990s, is a risky withdrawal rate.

But what is that risk? I mean, most retirees know nothing about this study or this table. They aren't even calculating their withdrawal rates, and most of them aren't running out of money. What is going on? Maybe we need to understand that so we can make a reasonable reply to the conservative folks recommending a 3.5% withdrawal rate and the even more extreme folks recommending a 2.5% withdrawal rate. Or even the folks arguing for a complicated withdrawal strategy requiring the use of continual adjustments, calculators, guidelines, and guardrails.

The Real Risk of Running Out of Money

Let's see if we can calculate the real risk of running out of money in retirement for a multi-millionaire physician retiree. Let's say these docs retire with $5 million, and they are willing to run reasonable risks in their lives. What exactly has to happen for them to run out of money?

Five things, really. And they all have to happen; not just one of them.

#1 They Have to Be Withdrawing More Than a SWR Would Suggest

We can argue if that is 4%, 3.75%, 3.5%, or whatever. But if the likelihood of failure is 0% by all possible calculations (like any number under 3%), they're never going to run out of money, no matter what happens.

#2 They Have to Run into a Bad Sequence of Returns

Nobody is going to run out of money—even with a 7% withdrawal rate—if they get a great sequence of returns in retirement. With a 75/25 portfolio, a 7% SWR worked for 30 years 45% of the time. Those folks who retired in 2010 are going to do just fine.

#3 They Have to Actually Live Long Enough

The Trinity study used an arbitrary 30 years. But look how much better all of those numbers look at 15-20 years, the actual life expectancy of a 63-68 year old retiree. At 75/25, a 6% withdrawal rate worked 97% of the time for 15 years. Always remember the lesson of the Rich, Broke, or Dead chart—where green is rich, red is broke, and black is dead.

Far more people die early than go broke.

#4 They Have to Continue to Spend the Same Amount During the Slow-Go Years as They Were During the Go-Go Years

Retirement spending is typically referred to as a smile. David Blanchett drew it like this in 2014:

Blanchett thought spending dropped 20% or so during the slow-go years. I have no idea if that is accurate, but for most people, it drops after the initial excitement of travel and fun activities turns into more of a burden.

#5 They Can't Make Any Adjustments If All of the Above Actually Happens

Flexibility in retirement spending is extraordinarily valuable. You might be surprised just how flexible you have to be to use an aggressive withdrawal rate (Big ERN suggests it could require spending cuts of as much as 50%), but if your spending is very flexible, that is an option. Certainly, any amount of flexibility can help reduce the risk of running out of money, and most people retiring with multiple millions have quite a bit of flexibility in their budgets.

More information here:

How Flexible Might You Have to Be in Retirement?

Comparing Portfolio Withdrawal Strategies in Retirement

Do the Math

Now, let's assign some probabilities to these numbers and do some math. Let's use a withdrawal rate of 5%, which is obviously more than a “safe” withdrawal rate. And let's say a bad sequence of returns (basically, the economy tanks just as you retire or soon after) shows up. With a 75/25 portfolio, that's 18% (at 30 years). Now, let's say you're 65 and single. What are the odds you live 30 years? If you're male, it's 5%. Let's multiply 18% x 5%. That's 0.9%. That seems awfully low, no? Even if you use the 20-year number (5% chance of running out of money) and multiply that by the chance of still being alive after 20 years (37%), you end up with 1.85%. Now reduce that 0.9%-1.8% for the other two factors, spending less in the slow-go years and making some adjustments as you go. I have no idea how to do the math for that, but let's say you get it down to 0.5%. That's 1 out of 200.

Are you willing to run risk like that in your life? I certainly am. Certainly, most people who start out with a 5% withdrawal rate are clearly NOT going to run out of money.

More information here:

Here’s How Much the Man Who Invented the 4% Rule Actually Spends in Retirement (Spoiler: It’s More Than 4%)

How to Spend Your Nest Egg — Probability vs. Safety First

How WCI Readers Live, Worry, and Withdraw Money in Retirement