By Dr. Jim Dahle, WCI Founder
White coat investors know that I like to make fun of all of the retirement researchers who come up with literally hundreds of withdrawal rules that show you how best to spend your retirement nest egg to ensure you don't run out of money before you run out of time. For those for whom it matters (which is not all that many white coat investors because there are so many oversavers among us), I prefer a much less formal plan I call “start at around 4% and adjust as you go.”
If you have no idea what I'm talking about in the above paragraph, why don't you start by reading these posts?
- The Silliness of the Safe Withdrawal Rate Movement
- Fear of the Decumulation Phase in Retirement
- A Framework for Thinking About Retirement Income
- Comparing Portfolio Withdrawal Strategies in Retirement
- How Flexible Might You Have to Be in Retirement?
How to Know If You Need to Adjust
There are two questions a retiree needs to address each year or so as they go throughout retirement, spending their money. The first is whether an adjustment is necessary. This is where the real strength of the part of my recommendation to “start at about 4%” comes in. You see, the historical data, limited as it may be, shows that you can withdraw 4% of the initial nest egg each year, adjusted upward for inflation, and expect to have a very low likelihood of running out of money in a 30-year retirement. Most people aren't even retired for 30 years because they die sooner than that, but that's how the studies were set up. So, if you start at about 4% (and if you want to be conservative, you can drop that to 3.75% or a very conservative 3.5%, which is not unreasonable if you're retiring in your 40s or 50s), almost all of your adjustments will be upward, not downward!
This is very similar to the “ratcheting” type withdrawal plans, where you increase withdrawals/spending as the portfolio grows in retirement. If you find your portfolio is 25%, 50%, or 100% bigger than what you retired with, that should be a sign that you can safely increase spending without worry about running out of money. If nothing else, just imagine you were retiring today instead of a year ago or four years ago. Is 4% of the current portfolio more than 4% of your original portfolio adjusted for inflation? Then, go ahead and use the new 4% as your number.
If you've decided to roll the dice a bit and spend 5%, 5.5%, or 6%, you have to keep a much closer eye on this process. Remember, if the sequence of returns risk—SORR (the risk that you run out of money despite having adequate average returns because the crummy return years show up earlier in your retirement)—appears, you have to be very flexible with your withdrawals, cutting them by 25% or even 50%. Instead of 5.5%, maybe you're now withdrawing 2.75%—and you may have to do that for five or even 10 years during the highest spending period of your retirement if there aren't a few great return years rescuing your portfolio.
However, for the typical person spending something closer to 4%, I would simply run the numbers once a year and see how it's going. I would compare what my spending looks like to a few of the more formal retirement withdrawal plans to see how it looks.
Is your portfolio larger or smaller than the initial portfolio at the time of retirement? Does 4% of the initial portfolio value plus inflation still cover your desired level of spending? What percentage of the current portfolio will you be withdrawing this year? Does that number seem really high (like >8%) even though you still anticipate decades in retirement?
How does your planned withdrawal this year compare to what you took out in previous years? Less? About the same? A little more? A lot more?
How much could you withdraw this year if you were following an RMD plan? RMDs are:
- Age 75: 4.1%
- Age 80: 5.0%
- Age 85: 6.3%
- Age 90: 8.2%
- Age 95: 11.2%
Some even advocate that you can multiply those numbers by 1.5 and still be fine, which would give you a table that looks like this:
- Age 75: 6.1%
- Age 80: 7.4%
- Age 85: 9.4%
- Age 90: 12.3%
- Age 95: 16.9%
If you're 80 years old and you're withdrawing 4.5% of the current portfolio value, you can surely withdraw and spend more. If you're in the 5%-7% range, you're doing fine and probably on track. If you spent 9% or 14% last year, there's a real issue—running out of money should be a serious concern for you, and it's time to dial back. Way back.
There are lots of other rules with which you can compare your spending. Pick two or three of them, project your spending rate against each of them each year, and make sure it never looks like what you're doing is nuts. If your spending level is failing all of the suggested spending plans, that should be a sign to you.
More information here:
One Retirement Withdrawal Strategy Shines If Maximizing Quality of Life While Living Is Your Goal
I’m Retiring in My Mid-40s; Here’s How I’ll Start Drawing Down My Accounts
What Is the Guyton-Klinger Guardrails Approach for Retirement?
Another Tip for the Underspenders
One other thing to consider for the underspenders is that you can go back and take the withdrawals you didn't take out in the last few years. Let's say you retired at 65 with a million bucks and figured you could spend $40,000 a year. For the first four years of retirement, you've just been living on your pension and Social Security, but this year, you want to do a home renovation. How much can you afford? Assuming no growth at all, there's $160,000 in the portfolio that you could have taken out in past years, plus this year's $40,000. So, unless the last four years have been the equivalent of 2000-2002 or 2008 or 2022, you should feel pretty comfortable taking out a couple hundred thousand dollars and spending it.
How to Adjust
If the first question is whether an adjustment is necessary, the second question is, how do you adjust? If you want formal instructions for either of these, I would suggest that you adopt one of the hundreds of withdrawal rules out there. If you're comfortable eyeballing it, then the adjustment is basically that you spend more when times are good and less when times are bad. The better the times are, the more you can spend. The worse the times are, the less you can spend.
But if your comparison to the 4% rule or the RMD rule shows you haven't been spending more than those rules allow, you can rest assured that, unless the future is even worse than anything seen in the past, you don't have to cut back at all. As a maximum cut, dialing back to 4% of the current portfolio value seems more than enough. You don't have to cut all the way back to just the income from a typical stock-and-bond portfolio, but if you're really worried, you could do that. That's probably the equivalent of cutting back to a rate of 2%-3% of the current portfolio.
How much can you adjust upward if times are good? If you have been spending $100,000 a year and you're now 85 and have a $3.5 million portfolio, you could safely increase that to at least 4% of current value ($140,000) and probably to 6%-9% of current value ($210,000-$315,000). You probably should have increased spending a year or three ago.
Those are the sorts of adjustments I'm talking about when I say “adjust as you go.” You need to know yourself. If you're a natural cheapskate and saver like I am, you probably need to push yourself to spend a little more on things that would actually make you happier. If you know that controlling spending has always been tough for you, you'll need to be a little bit more careful.
What do you think? Do you plan to follow a formal withdrawal plan or adjust as you go? Which is your favorite plan? If you are retired, how have you adjusted your spending as time goes on?
After spending six or seven years trying to figure out the answer to this very question I’ve landed on what I believe is the best solution there is: risk-based spending guard rails.
What I like about RBG approach is it takes all the guesswork out of whether I’m spending too much or too little. This is especially important early in retirement when you’re in your gogo years and the spending is probably going to be higher than at any other time in your retirement at least until the very end (cf, “retirement smile”).
Agreed.
Here’s a good summary by Kitces. The impressive thing to me is the magnitude of the risk you can apparently tolerate—spending is only adjusted once you hit a 25% probability of “success”.
https://www.kitces.com/blog/guyton-klinger-guardrails-retirement-income-rules-risk-based/
Tom, do you use historical data (like FI Calc) or Monte Carlo sims (like Empower) to generate your risk? I believe Kitces’ example uses historical data, which is why the upper guardrail can reach 100%. But since Monte Carlo sims incorporate extremes that have never occurred, it’s really hard to get to 100%. Since I’m not confident the future will resemble the past, I use Monte Carlo, but move the guardrails a little closer together.
Anyway, I am not fully depending on investment income yet, so will have to defer to others about this strategy in the wild. Possibly in the end I will just eyeball it, since spending is lumpy, and life happens.
The downside of the more complex methods are that you may need someone else managing it in the later years. But the most important ones are the early, higher spending years and that’s when your own competence is also highest.
Hey Jim thoughtful post as always I agree that definitely one of the downsides of the ratcheting rule is it’s complexity, but I like it as you said you can make it less complex as cognition wanes in later years. I’m a big fan of the ratcheting rule as I don’t have any legacy goals and have a die with zero mentality. The rule seems to be the best framework to maximize spending for your own happiness if you don’t have any legacy goals.
Maybe you’ve discussed this elsewhere? For many, the resources available for retirement income aren’t just investments. There is also SS, and possibly a pension.
For example. I’m 62. If I just use a SWR (safe withdrawal rate) based on investments I’d withdraw about $100000 now. But in 2025 my spouses SS bumps it $13000. In 2028 a pension adds $55000, and in 2033 my SS adds another $50000. And who can even guess about RMDs?
Early retirement now (ERN) has a calculator that helps smooth all of that out. Allowing me to withdraw a higher percentage now, knowing that I’ll withdraw a lower percentage later.
I think that probably increases sequence of return risks, so I keep a few years in cash equivalents, at least until 70 when over half will be provided by guaranteed income.
More guaranteed income reduces SORR. One way to think about your dilemma is to just set aside $55,000 a year for the next 3 years in a MMF or TIPS ladder until the pension comes in etc. and withdraw based on what’s left after that.
I have developed my own “Retirement Flowsheet ” using an Excel spread sheet. My columns start with year/age, AGI, Pension self, Pension wife, Social Security Self, Social Security wife, Passive income (In my case rentals minus expenses), Total income (=SUM(A2,B2,C2,D2,E2,F2)), then Cash/Brokerage, 401k/IRA, Roth, RMD, Need, then finally Net worth. I have rows for each year/age out to age 80 then a 10 year row to get to 90. My need is based upon how much I spent in the previous year and I include; donations, 529 plans for the grandkids, Gifts to my kids etc. so I can get an idea of how much I can afford to give with warm hands. Some years assets grow better than others and some years expenses are greater. This year we are replacing windows. It gives me an anticipated plan so that I can die close to zero. I don’t include anticipated financial returns, non financial assets, property valuations etc. It is a working table, so as it changes I keep annual copies.
The 4% guideline is fine for pre-retirement, but after that with the end approaching, it is worthwhile taking a second look.
My method is simple though it can result in variances which some might not like. I take my five year average return (not a generic number from retirement websites), the five year average inflation rate, how long I have until I reach 100, my yearly spending and plug them into this: https://www.mycalculators.com/ca/retcalc2m.html
I recalculate yearly.
Great point, Will. I agree the 4% Rule is ideal for pre-retirement planning purposes.
I haven’t found a better tool to help people figure out how much retirement savings they might need to sustain their current lifestyle. It can’t get any easier: take your current annual spending and multiply it by 25. That’s how much retirement savings you should plan for.
This easy math is eye-opening for a lot of my students. I’ve seen that my younger students are typically horrified at how much money they’ll need based on their current spending levels. After the jolt, they are relieved at how much their magic retirement number drops if they can commit to reducing their spending.
On the flip side, my older students tend to get excited after doing the math because they realize they’re so much closer to being able to retire than they thought. As the WCI pointed out, a lot of us are saving too much.
Great post and great comments.
Matt
I like the “adjust as you go” plan.
Compare to picking something up at the grocery store. You can have a fifty page rule book: Stay in the right lane. If there is a car stopped there, switch to the left lane. If your car drifts out of the lane, …. Park near the store. If a car is in your space, look at the next space. If the entire row is taken up, ….
Or else the one line version: Drive towards the store. If some issue comes up, you will know what to do.
Even ultra-conservative Wade Pfau has said that spending only RMDs is a conservative withdrawal approach and likely overly so. As one’s retirement horizon shrinks, it’s only logical that the withdrawal rate CAN increase, though most retirees spend less and less as they age up until around age 85-90 due to medical expenses. That’s a big part of the reason why I think it’s reasonable for younger retirees to start with a slightly higher withdrawal rate (e.g., 5% or more) and slowly dial it back as they age.
Thanks. I like these pertinent, informative posts. Interesting that you pointed out that underspenders “can go back and take the withdrawals”– something that had crossed my mind, even though I’m not sure in what situation I’d do it.
I retired in June of ’22, so am at the beginning of year four in retirement. Unexpected part-time income has helped keep my withdrawal rate under 3% and today I have a whole lot more than when I retired, therefore I’m looking to adjust upward. However, I’m also a “natural cheapskate,” even though I do fun things and don’t feel like I needlessly skimp. So I might have to work at it some to make “adjusting upward” a reality beyond relatively small increases.
Finally, for me and I’m assuming others, having part-time work to begin retirement has been a big plus for additional peace of mind monetarily, as well as offering a bit of satisfaction in still contributing in some way.