Four Percent Withdrawal Rate May Be Too High for Today's Retirees

Last Updated Sep 22, 2011 6:49 PM EDT

A recent paper has called into question the generally accepted rule that four percent is the amount you can safely withdraw from IRAs, 401(k) accounts, and retirement savings to generate reliable, lifetime retirement income. While analysts and financial planners have long advocated the four percent rule, or some variation of it, it may no longer make sense in today's environment.

Before we dig into the conclusions of this paper, let's briefly review the four percent rule, which goes like this:

  • Invest in a portfolio balanced between stocks and bonds
  • Withdraw four percent of your account in the year you retire
  • Give yourself raises for inflation each year thereafter.
By using this method of generating retirement income, the theory goes, the odds are very low that you'll outlive your retirement savings for periods of retirement that are up to 30 years long.

One common analytical argument for the four percent rule goes like this:

  • Look at every possible 30-year retirement period in the past, for as many years for which reliable, historical investment data is available.
  • Assume you invested in a specific asset allocation between stocks and bonds and earned historical rates of return.
  • Calculate the safe withdrawal rate for each of these periods, given the specific asset allocation.
The analyses then spell out, for all of these possible retirement periods, how often a specific withdrawal rate failed (meaning you would have outlived your money). Past results have always shown that a four percent withdrawal rate has had low failure rates across all the time periods studied for portfolios that were balanced between stocks and bonds.

Another common analytical argument for the four percent rule constructs a probabilistic model that prepares 500 to 1,000 projections of investment returns over 30 years based on historical returns and potential deviations from these returns. The probability of failure (i.e., outliving your retirement savings) is then estimated under various withdrawal rates and specific asset allocations. These models deem a withdrawal rate to be safe if the estimated failure rate is below certain thresholds, such as one out of 20 (5 percent) or one out of 10 (10 percent).

Both types of analyses can be used to analyze periods of retirement different from 30 years, and as you'd expect, shorter retirement periods can generate higher safe withdrawal amounts, and longer periods lower safe withdrawal amounts.

With this background in mind, let's now look at the paper that calls into question the safety of a four percent withdrawal rate in today's economy.

Next: Why four percent may not be a safe withdrawal rate in today's environment

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.