“In retirement, we want to be fairly certain that our investments will last as long as we do. With that in mind, how much can we safely withdraw from our investments?”

Over the past 30 years, most retirement planners have answered this question by explaining the “4% rule of thumb”.

The 4% rule of thumb suggests that with a diversified portfolio split evenly between U.S. high-quality stocks and U.S. high-quality bonds, over a 30-year retirement, retirees can safely withdraw 4% of their portfolio each year and then adjust their withdrawal their next year based on the rate of inflation.

For example, suppose a retiree has $1,000,000 in investments split evenly between U.S. high quality  stocks and bonds. The 4% rule of thumb suggests that the retiree could withdraw $40,000 in the first year of retirement. Now, suppose that the inflation rate at the end of the first year is 2.5%. In the second year, the retiree could withdraw $40,000 + (2.5% of $40,000= $1,000) for a total of $41,000.

The two variables that most affect the success of the 4% rule of thumb are the retiree’s investment time horizon and the retiree’s asset allocation:

• The retiree’s investment time horizon is usually based on life expectancy tables. Today, unless a retiree is in poor health, planning to live into your 80’s or 90’s is a reasonable assumption. For example, with a 65-year-old married couple, there is an 80% chance that at least one spouse will live to age 85; a 55% chance that at least one will live to age 90; and a 25% chance that at least one will live to age 95. If a retiree expects to have a 30-year time horizon, the 4% rule of thumb may be appropriate. On the other hand, if a retiree has a longer time horizon, a withdrawal rate of 3% may be more appropriate, while retirees who have a shorter time horizon may be able to withdraw 5% per year, and perhaps more.
• In addition to retiree’s life expectancy, the retiree’s investment asset allocation also has a major impact on the success of withdrawals. For example, a portfolio with a higher allocation to stocks may support higher withdrawal amounts than a portfolio with a higher allocation to bonds. However, a higher allocation to stocks will also result in less certainty of results. Retirees who need more certainty of results may want to allocate more of their investments to bonds and other less volatile asset classes. These retirees may also wish to adopt various financial strategies that generate predictable lifetime income.

While the 4% rule of thumb is widely used, at Goepper Burkhardt we don’t believe in relying on “rules of thumb”. Rather, we design and monitor a custom retirement withdrawal strategy for each of our clients.