The Stunning Problem With The 4% Retirement Income Rule in One Chart

[MULTIZ321]

The Stunning Problem With The 4% Retirement Income Rule in One Chart.

The Stunning Problem With The 4% Retirement Income Rule In One Chart

Many investors rely on the "4% retirement rule", but it has a serious problem. If you are nearing retirement, you need to understand "sequence of investment returns" because it can mean the difference between a retirement with plenty of income and one where you run out of money.

www.forbes.com

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Richard

 

[bluehende]

Nice article with one glaring error. I saw nowhere that they took inflation into the equation. While tame now inflation is bound to pick up at some point. While it may be fashionable to assume the business cycle no longer exists it is not a good idea to base your future finances on that.

 

[geekette]

Inflation for this example is an after-you-pocket-the-money situation, doesn't enter into the demo. Taxes are in same category. I am of course with you, that the erosion of buying power is a real issue.

The problem with the article, for me, is the assumption that all retirement monies are in the market. Sure, one could deplete their market money in 15 years but there is no market risk to annuities, pensions, SS, etc. As a dividend investor, sequence of returns risk isn't a thing for me because I am not a seller.

 

[WinniWoman]

Our FA does not like the 4% rule. He says everyone has different spending needs and withdrawal rates have to be based on that, not a strict 4% number.

 

[rhonda]

Their tables show a flat $40k withdrawal (4% of the opening value) every year. Wouldn't one general take 4% of the balance at some "moment in time" each year? I have one account with an RMD. My withdrawal varies year to year depending on year end balance and my age.

 

[GetawaysRus]

The real problem with the article is that it ends with this sentence:

In upcoming Forbes articles, I will discuss several strategies to reduce the sequence of returns risk.

That's what would really interest me, if that is even possible. Now I have to hope that Richard posts a link to the follow up article(s)!

(I'll save the author's name and try a search sometime in the future to see if I can find the future articles. )

 

[MULTIZ321]

The real problem with the article is that it ends with this sentence:

In upcoming Forbes articles, I will discuss several strategies to reduce the sequence of returns risk.

That's what would really interest me, if that is even possible. Now I have to hope that Richard posts a link to the follow up article(s)!

(I'll save the author's name and try a search sometime in the future to see if I can find the future articles. )

Hi GetawaysRus,

If I see it, I'll post it.

Richard

 

[zinger1457]

Our FA does not like the 4% rule. He says everyone has different spending needs and withdrawal rates have to be based on that, not a strict 4% number.

Setting your withdrawal rate based solely on your spending needs could be a recipe for disaster if your spending needs are way above your ability to support it in the long term. The idea behind the 4% rule is that it's close to the maximum withdrawal rate one could take and not run out of money during retirement, obviously one could take less if the 4% amount wasn't needed. The article does miss the boat with respect to inflation, it's not reasonable to expect someone to live off the same amount over a ~30 year period. The 4% rule does take this into account and the withdrawal amount should be increased by inflation (~2-3%) every year.

 

[Blues]

In upcoming Forbes articles, I will discuss several strategies to reduce the sequence of returns risk.

That's what would really interest me, if that is even possible. Now I have to hope that Richard posts a link to the follow up article(s)!

I've never heard of this Forbes writer, so I'd take his advice with a grain of salt. OTOH, two of the most respected names in retirement planning, Michael Kitces and Wade Pfau, both recommend a "bond tent" to mitigate the sequence of returns risk. That is, increasing the allocation to bonds for a number of years around retirement. Here's Kitces' article:

The Portfolio Size Effect And Optimal Equity Glidepaths

How the portfolio size effect impacts the optimal asset allocation glidepath of a lifecycle or target date fund, and how a bond tent reduces volatility risk.

www.kitces.com

 

[x3 skier]

Gee, if you lose money in your portfolio at the start and keep taking the same $ amount out, you’ll run out before if you would if you made money at the start and keep taking out the same $ amount. This is a “Stunning” revelation?.

 

[VacationForever]

I like the RMD model as your money never gets to zero or negative. My complaint is that it makes us take too much money as time goes on. OTOH it takes care of inflation with increased withdrawal each year. It is all good.

 

[rhonda]

I like the RMD model as your money never gets to zero or negative. My complaint is that it makes us take too much money as time goes on. OTOH it takes care of inflation with increased withdrawal each year. It is all good.

Pity the kids who inherit an IRA now that Secure Act in in place. They have just 10 years to drain the inherited IRA.

 

[capjak]

Gee, if you lose money in your portfolio at the start and keep taking the same $ amount out, you’ll run out before if you would if you made money at the start and keep taking out the same $ amount. This is a “Stunning” revelation?.

Some people do not realize that if two portfolios over a 30 year period both average 6% return over the 30 years that the one that had negative returns at the start will run out sooner (sometime much sooner) though they both had the exact same 6% annual return. Likewise they do not under stand that if you lose 50% of your portfolio that it takes a 100% return to get back to the starting amount: (100 dollars lose 50% have 50 dollars, now I need to double my 50 dollars to get back to even). It's not that transparent to some....

 

[capjak]

I like the RMD model as your money never gets to zero or negative. My complaint is that it makes us take too much money as time goes on. OTOH it takes care of inflation with increased withdrawal each year. It is all good.

Than you might also like the Boglehead Variable Percentage Withdrawal strategy as it mitigates the risk of running out of money:

https://www.bogleheads.org/wiki/Variable_percentage_withdrawal

Variable percentage withdrawal (VPW) is a method which adapts portfolio withdrawal amounts to the retiree's retirement horizon, asset allocation, and portfolio returns during retirement. It combines the best ideas of the constant-dollar, constant-percentage, and 1/N withdrawal methods to allow the retiree to spend most of the portfolio using return-adjusted withdrawals. By adapting withdrawals to market returns, VPW will never prematurely deplete the portfolio.

The VPW method uses a variable (increasing) percentage to determine withdrawals from a portfolio during retirement. Each year, the withdrawal is determined by multiplying that year's percentage by the current portfolio balance at the time of withdrawal.

 

[sue1947]

Pity the kids who inherit an IRA now that Secure Act in in place. They have just 10 years to drain the inherited IRA.

As opposed to getting nothing? I don't think getting money you didn't work for as something to be pitied. Even paying taxes at a higher rate still results in a net gain for them. No pity here.

 

[geekette]

Pity the kids who inherit an IRA now that Secure Act in in place. They have just 10 years to drain the inherited IRA.

Hard to muster pity for someone that just got a big account they must empty on a timeline.

 

[rhonda]

As opposed to getting nothing? I don't think getting money you didn't work for as something to be pitied. Even paying taxes at a higher rate still results in a net gain for them. No pity here.

Hard to muster pity for someone that just got a big account they must empty on a timeline.

I s'pose I'm seeing it differently having lost my parents while they were still fairly young. As oldest and executer of the estate, splitting up their IRA was one of the first tasks due to both "ease of task" and an Inherited IRA deadline. I don't think any of us were ready to receive a chunk of money at that moment. We were still reeling from the unexpected loss and exhausted. As for my share, I've been fortunate to only take the RMD and to watch the original deposit grow. I've had the luxury of reinvesting the annual distribution, most years, and to see those deposits also growing. I'm not so sure I'd have done as well if I'd been forced to drain the account w/in 10 years. The first 5 years, maybe longer, were emotionally crazy.

 

[Talent312]

Even paying taxes at a higher rate still results in a net gain for them. No pity here.

Someone I knew said, "I prefer having to taxes than not have any to pay."
.

 

[rapmarks]

I s'pose I'm seeing it differently having lost my parents while they were still fairly young. As oldest and executer of the estate, splitting up their IRA was one of the first tasks due to both "ease of task" and an Inherited IRA deadline. I don't think any of us were ready to receive a chunk of money at that moment. We were still reeling from the unexpected loss and exhausted. As for my share, I've been fortunate to only take the RMD and to watch the original deposit grow. I've had the luxury of reinvesting the annual distribution, most years, and to see those deposits also growing. I'm not so sure I'd have done as well if I'd been forced to drain the account w/in 10 years. The first 5 years, maybe longer, were emotionally crazy.

My broker said many of his clients have the bulk of their retirement in an Ira. Passing it on to your children at the height of their earnings will cause them a very big tax bill. I think someone said anticipating 18 billion of additional taxes.

 

[rhonda]

I think someone said anticipating 18 billion of additional taxes.

I'm thinking reaping additional taxes was the driving force behind the Secure Act. Personally, I view it somewhat "family unfriendly" but, perhaps, it is greatly appreciated by those not forced into withdrawals at 72.

 

[WinniWoman]

As opposed to getting nothing? I don't think getting money you didn't work for as something to be pitied. Even paying taxes at a higher rate still results in a net gain for them. No pity here.

Really? Well their deceased Parents worked hard for that money and I am sure their parents would have wanted their children to have THEIR money and not the government.

This is why I hate things like IRAs and 401ks ( which most of our money is in as well). They are deceiving and are really tax DIS- advantaged. Anything the government has a hand in forget it. In the long run better to have had a taxable account.

 

[GetawaysRus]

I looked at the Kitces article that Blues recommended that discusses a "bond tent."

I'm a California resident, so I have long bought California municipal bonds and I have a decent tax free income-generating bond stash. The current problem with this approach is that interest rates are stunningly low and not likely to go anywhere fast. So this creates a dual problem:
1. It's gotten very difficult to find bonds paying a decent rate without dipping into low quality issues (which I don't really want to do).
2. Rates are so low that bonds keep getting called. It makes sense for municipalities to issue a new bond at a lower interest rate and pay off higher interest older issues. When a bond in my account gets called, it's gotten extremely difficult to replace it with anything attractive.

 

[sue1947]

Really? Well their deceased Parents worked hard for that money and I am sure their parents would have wanted their children to have THEIR money and not the government.

This is why I hate things like IRAs and 401ks ( which most of our money is in as well). They are deceiving and are really tax DIS- advantaged. Anything the government has a hand in forget it. In the long run better to have had a taxable account.

It's not entirely THEIR money. That money hasn't been taxed yet. Some of that IRA is tax that hasn't been paid yet. It's going to be at some point so the parents have chosen to pass that tax obligation onto their kids. If they don't want that, then they need to pay the tax OWED (to the American taxpayers) themselves.
And again, if anybody inherits money, whether taxed or not, they are getting additional money and are not to be pitied.

Sue

 

[rapmarks]

It's not entirely THEIR money. That money hasn't been taxed yet. Some of that IRA is tax that hasn't been paid yet. It's going to be at some point so the parents have chosen to pass that tax obligation onto their kids. If they don't want that, then they need to pay the tax OWED (to the American taxpayers) themselves.
And again, if anybody inherits money, whether taxed or not, they are getting additional money and are not to be pitied.

Sue

If someone would just tell the parents their date of death then they could empty their ira. But they probably are worried about making their money last long enough to pay for the extra care they will probably need as the live out their lives. Or do you suggest they spend it all and apply for Medicaid?

 

[WinniWoman]

It's not entirely THEIR money. That money hasn't been taxed yet. Some of that IRA is tax that hasn't been paid yet. It's going to be at some point so the parents have chosen to pass that tax obligation onto their kids. If they don't want that, then they need to pay the tax OWED (to the American taxpayers) themselves.
And again, if anybody inherits money, whether taxed or not, they are getting additional money and are not to be pitied.

Sue

I am not implying they should not pay tax, but they should be able to spread it out longer than 10 years.

Parents do not get to choose when to die or to vote on these laws.