New Math for
Retirees and the 4% Withdrawal Rule
More than two decades ago, Bill Bengen, then a
financial planner in Southern California, said he had several anxious
clients with the same question: How much can I spend in
retirement without running out of money?
Being relatively new to the profession, he dived back into his finance
textbooks for answers, but said he couldnˇ¦t find any guidelines rooted in
facts. ˇ§I decided to get down to business with my computer,ˇ¨ said Mr. Bengen,
67, who retired in 2013 and now lives with his wife in La Quinta, a resort
town in Californiaˇ¦s Coachella Valley.
What he and his computer produced, in 1994, became part of the financial
vernacular and is still the most widely referenced rule of thumb. Known as the
4 percent rule, it found that retirees who withdrew 4 percent of their initial
retirement portfolio balance, and then adjusted that dollar amount for
inflation each year thereafter, would have created a paycheck that lasted for
The concept has been both celebrated and criticized, and it has recently come
under scrutiny yet again, particularly as the current crop of retirees are
entering retirement during a period of historically low interest rates. But
the question of how much they can safely spend each year may be more important
than ever: Roughly 11,000 people, on average, are expected to turn 65 every
day for the next 15 years, according to the Social Security Administration.
ˇ§I always warned people that the 4 percent rule is not a law of nature like
Newtonˇ¦s laws of motion,ˇ¨ said Mr. Bengen, who graduated from the
Massachusetts Institute of Technology with a bachelorˇ¦s in aeronautics and
astronautics in 1969. ˇ§It is entirely possible that at some time in the future
there could be a worse case.ˇ¨
Mr. Bengenˇ¦s original analysis assumed the retireesˇ¦ portfolio was evenly
split between stocks and bonds, and he tested whether the paycheck could
persevere through every 30-year period dating from 1926. It succeeded.
The big question now ˇX difficult even for an aerospace engineer to answer ˇX is
whether a new worst case is beginning to play out, given the painfully low
interest rate environment, which yields little for safer bond investments,
where retirees often hold a big portion of their money.
Strategies for Retirement Spending
Aside from the original 4 percent rule,
retirement experts have devised more complex methods to help retirees
determine what percentage of their nest egg they can safely spend each year
for 30 years, without running the risk of entirely running out of money.
ˇ§Because interest rates are so low now, while stock markets are also very
highly valued, we are in uncharted waters in terms of the conditions at the
start of retirement and knowing whether the 4 percent rule can work in those
cases,ˇ¨ said Wade Pfau, a
professor of retirement income at the American College of Financial Services
and another researcher within the financial planning community.
Since Mr. Bengenˇ¦s original
published, the 4
percent concept has been
criticized and even
refined by Mr. Bengen himself. (By using a more diversified portfolio, he
later raised the rate to 4.5 percent.)
Critics of the rule point out that it is based on conditions in the United
States during a very specific time in history; it also doesnˇ¦t take into
account items like investments costs, taxes, different time horizons or the
reality that most retirees donˇ¦t spend their money in a linear fashion. Some
people may want to spend more early in retirement and may be willing, even
comfortable, making cuts when the market plunges once again. And if retirees
want to leave money to their children, they may need to trim their spending
Sorting all of this out, particularly without a cushy pension to fall back on,
is a complicated task, even for a numbers-savvy retiree. Still, the original 4
percent rule persists as a
starting point, and some retirement experts are still comfortable
suggesting similar withdrawal rates, with some caveats and new twists of their
In a recent analysis, Mr. Pfau compared several withdrawal strategies in an
attempt to illustrate how spending patterns might change to guarantee that a
portfolio will last for 30 years, even if low rates persist or retires face
some other awful combination of events.
He found that people who spend a constant amount adjusted for inflation ˇX
similar to the 4 percent rule ˇX would have to reduce that rate to 2.85 to 3
percent if they wanted assurance that their spending would never have to dip
below 1.5 percent of their initial portfolio (in inflation-adjusted terms).
So a retiree with $1 million could securely spend nearly $30,000 annually for
30 years, in the best and worst of market conditions. The big drawback,
though, is that if economic conditions are generally average, retirees would
be left with $794,000 in unspent money. If they were unlucky and experienced
terrible market conditions, they would be left with $17,900.
Thatˇ¦s the trouble with this strategy. ˇ§Most of the time, you underspend,ˇ¨
said Mr. Pfau, who is also a principal at McLean Asset Management. ˇ§Yet you
still run the risk of running out.ˇ¨ Bill Bengen and his wife, Joyce. His own financial
advisers are proponents of the 4 percent rule.
Credit Jaime Kowal for The New York Times
Other retirement experts, including Michael Kitces, director of research at
the Pinnacle Advisory Group, are still comfortable recommending early
withdrawal rates of about 4 percent. He has likened the current environment ˇX
low interest rates and high stock market valuations ˇX to walking along
a cliff. Todayˇ¦s retirees are walking along the edge, which, he said
in his blog, required more caution and continuous monitoring. But that
doesnˇ¦t mean theyˇ¦re going to fall off.
4 percent rule was built around some rather horrific bear markets of the
past already,ˇ¨ he said. ˇ§Do we necessarily know or expect that the next one
will be so much worse than any of the other terrible historical bear markets
Mr. Pfau isnˇ¦t so sure. So his
study looked at different strategies beyond the 4 percent rule, some of
which allow people to spend a bit more early on, but also provided assurances
that spending wouldnˇ¦t dip below a certain level for 30 years. At least one
approach that he analyzed, using a portfolio evenly split between stocks and
initially created by Jonathan Guyton, a
financial planner with
Cornerstone Wealth Advisors in Edina, Minn., and allows an initial
withdrawal rate that approaches 5 percent.
To start that high, however, you need to follow a complicated set of rules:
Normally, annual withdrawal amounts can increase by last yearˇ¦s rate of
inflation. And in good years, retirees can generally increase withdrawals by
But no increase is permitted in years when the portfolio loses money. In fact,
a small spending cut might be necessary in that case: When balances drop below
certain levels ˇX causing your withdrawal rate to rise more than 20 percent
above the initial rate, say to 6.4 percent from 5.3 percent ˇX the next yearˇ¦s
withdrawal must be cut by 10 percent.
Tricky rules of that sort are likely to leave retirees scratching their heads.
Itˇ¦s hard envisioning even the sharpest of aging retirees, much less
the most vulnerable, following this sort of discipline on their own.
So perhaps itˇ¦s not all that surprising that Mr. Bengen said he had hired
not one, but two financial advisers ˇX both good friends ˇX to handle his
retirement money. Though his advisers rely on financial software, he said
they were proponents of the 4 percent rule.
ˇ§And my actual numbers probably come close to that,ˇ¨ said Mr. Bengen, who
spends his days honing his creative writing, playing the guitar, setting
up bridge and boating clubs and taking time to visit his 20-month-old
grandson. ˇ§I have followed my own advice.ˇ¨
But if he had advice to offer others, it is this: ˇ§Go to a qualified
adviser and sit down and pay for that,ˇ¨ he said. ˇ§You are planning for a
long period of time. If you make an error early in the process, you may
not recover. ˇ¨