As you approach retirement, one of the most pressing questions is how much you can withdraw from your savings without running out of money. The 4% rule, a popular guideline in retirement planning, suggests that you can withdraw 4% of your retirement portfolio in the first year and adjust that amount for inflation each subsequent year. This rule, developed by William Bengen in the 1990s, was designed to ensure that retirees wouldn't outlive their savings over a 30-year retirement. But how does this rule align with the actual spending patterns and lifestyle of retirees today?

Stay tuned as Ryan shares why he believes that this rule is overly conservative, and not a one-size-fits-all solution for everyone. He’ll compare the 4% rule with 5% and 6% withdrawal rates, stress testing these strategies to see how they hold up over time, given market volatility and other factors. He'll also explore what different scenarios might look like, including the impact of incorporating annuities into retirement income planning.

**Here’s what we discuss in this episode:**

0:00 – Intro

1:01 – Looking at the 4% rule

4:15 – Comparing 4%, 5%, and 6% withdrawal rates

8:42 – Stress testing each withdrawal strategy

13:47 – Incorporating annuities into your plan

20:43 – Conversation takeaways

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**Full Transcript:**

(00:00):

Once you retire or even as you approach retirement, one of the key questions of course is how much can you spend? The paychecks now stopped, you're now retired, hopefully now you've built up a nice sized nest egg, nice sized portfolio. And so the question is how much can you spend from it? How much can you withdraw on a monthly basis, let's say, and hopefully not run out over the course of your lifetime. So we're going to talk all about it here today.

(00:26):

This is Candid Conversations Retirement Talk with Ryan Cravitz of Cravitz Financial & Insurance Solutions.

(00:35):

Alright, today my co-host Ben is on vacation. So I said, no problem. I will take it this week. You enjoy yourself. So let's dive in here. This is a big topic lot to talk about. It's a big decision in figuring out how much can you can withdraw, how to structure that retirement income plan. And so want to talk about a few different things here with you. So first off, want to talk about the 4% rule. Now, I'm not a fan of the 4% rule, but for those of you that are not familiar with it, let me explain what it is first because it is important to understand this first as a starting point. So the 4% rule is not really a rule. It was an idea or a theory that was developed by a guy back in the 1990s by the name of William Bengen.

(01:25):

And the idea was is that over the course of a 30 year retirement, you could withdraw 4% of your portfolio the first year and then increase that by the rate of inflation. And if you had a 50/50 stock to bond type portfolio again over a 30 year retirement, you would be reasonably assured that you'd have a very high probability of not running out of money over the course of your lifetime. Now, I think it's good at least as a starting point, but there's a lot of things that I don't like about the 4% rule. I mean, first of which is that it assumes that you're going to have a 30 year retirement. Now there's no doubt that we're all living so much longer and that many of us will live more than 30 years in retirement. It will happen again. People are living so much longer.

(02:18):

My grandmother lived to be 102, so it's probably going to become more and more common in the future, more people living till a hundred. But nevertheless, it doesn't mean that everyone is going to have a 30 year retirement. Some people today are retiring at 70 or 75. Does it really make sense to plan for 30 years? Others maybe due to health issues or other things, the chances of really living for 30 years in retirement may not be realistic. So each person's situation's going to be much more nuanced, but at least it's fine I guess as a starting point. But here's the other thing too, is that even if you were to live 30 years in retirement and follow the 4% rule, I believe it leads to a lot of underspending. Typically what I find in working with retirees and soon to be retirees over the years is that most people want to spend more money in their early years of retirement and then want to scale that back over time.

(03:25):

And typically that's because you're now retired. Let's just say you're retiring at 65. I know not everybody does, but in the example we're going to look at here in just a moment, it's based on a 65-year-old. So let's say you retire at 65. Typically I find those first, especially five years to 10 years of retirement are when people want to be out there spending and doing more things. So with the 4% rule, it assumes that you want to spend in a linear fashion all throughout retirement. Where in the reality I find is once people get into their later seventies, into their eighties and perhaps into their nineties, they just tend to spend less. Now side note, healthcare costs are separate animal. I account for those always separately than I do all the rest of the living expenses. So let me share my screen here with you and let's go over a couple things here.

(04:22):

Alright, so what we're taking a look at here is this is three different scenarios. The one in the green here is it says 4% withdrawal and then 2.5% cola. So what I'm assuming here is somebody that's 65, again going to be retired for 30 years until 95, and with this column in the green we got 4% withdrawal. So we're going to withdraw $40,000. Now this number is just under that because I enter a monthly number into my software, which is 3,333, and we're going to adjust that by an assumed cost of living adjustment of 2.5% here over time. So we'll just assume that's the inflation rate. In the second scenario, the blue here, it's at 5%. So instead of withdrawing 4%, we're now going to withdraw 5% on this hypothetical million dollar portfolio, which by the way, it doesn't matter if you have a hundred thousand or if you have $10 million, it's all the same.

(05:22):

These are just percentages, and again, there's going to be a lot more that will change this as it gets specific to you and exactly what your spending needs are. The last one that you're going to see, or that you do see on the right is the 6% withdrawal. Now, this one does not assume that we're going to adjust by two and a half percent COLA all throughout retirement. This assumes only a 1% COLA. So I believe the 4% withdrawal rule is too conservative oftentimes even over a 30 year period. Now, there's been people in the media, and I won't name names, but big names that have mentioned that an 8% withdrawal rule is fine or 8% withdrawal rate in retirement is fine and that you could adjust that for inflation and that you should be okay. That I totally dismiss. That is way too high, certainly in my opinion, but based on all the analysis and things that I do now, it's not to say that it might make sense to withdraw at let's say 8% a year for a certain number of years and then scale that back.

(06:36):

But to think that you could start at 8%, increase that for the rate of inflation all throughout 30 years, that's not going to work with me. So here's three different scenarios here, 4% withdrawal, 5% withdrawal, assuming the same cola, and then 6% withdrawal assuming a 1% cola. Now in just a little bit, we'll look at what the likelihood of these actually holding up over time. But just for now, if we assume that your two choices in retirement are either to go with this one, the blue, the 5% withdrawal with this COLA, 2.5%. Or this one with the 6% withdrawal rate and a lower COLA, which option would you choose? So take a look here. You'll notice in the beginning you're better off with the 6% because getting $60,000 instead of basically $50,000 here. Okay? Now of course the COLA is smaller, so over time there's going to be a crossover here, right? So let's see what age, I think age 60 or 78. Yeah, so at age 78, if you went with this strategy with the 5%, you're going to get more money.

(07:56):

So the question is what would you rather have? Would you rather have more money here on the front end or would you rather have more money here on the backend? What makes more sense for you? Okay, now again, there's no right or wrong answer here, but again, typically what I find is most retirees want to do more spending here in the early years of retirement. And so some people have heard that a 5, 5 and a half or even 6% withdrawal rate might be too high. Well, it depends upon how many years we're planning in retirement. It depends upon the COLA that we're assuming and other factors. So let's dive in here and take a look actually kind of stress test this to see what the likelihood of these different strategies or based on these different withdrawal rates of them holding up over this 30 year period.

(08:59):

Now, there's always going to be a lot of assumptions in any of this type of analysis here. So for simplicity, what I'm assuming is more or less a more moderate type of allocation and a rate of return is about 7% and standard deviation just over 10.2. So the standard deviation, that wobble factor, right? So how much the portfolio tends to increase or go up and down over time, that's that volatility. The more volatility, the worse. You want to have more consistent rates of return, especially in retirement, especially when you're withdrawing money in retirement. So based upon the assumptions that I went with and I could have assumed a little bit higher rate of return perhaps with this type of portfolio, but I always like to error a little bit more on the side of being conservative. Then if there's more money later on, great, but don't want to be in a position where we run out.

(10:06):

So this shows an 88% probability of success over 30 years. And if we dive in deeper, what this is telling us is that there's only a chance based upon the simulation of possibly running out of money at age 90. So this still lasts at least for 25 years. In this case, again, if I would assumed a little bit higher rate of return, we would've been just fine all the way to 90. This is just what I'm comfortable with. And the reason why is because if you look at rates of return over the course of 50 years or 80 years, they could be one thing, but the reality is people don't retire over the course of 50 or 80 years. People retire over 15 years, 20 years, maybe 30 years. Retirement is a lot shorter. And we could go through periods of time where the markets, our investments do really well, like let's say the 1990s if you remember that.

(11:11):

Or we could go through a time period and you could retire, let's say in 2000 right at the start of the tech crash. And that was a really bad decade right there. So nobody knows what the next decade's going to have in store, and especially that first decade of retirement is absolutely critical to the success of your portfolio due to sequence of returns risk and other things beyond the scope of what we're talking about here. So bottom line, this is we're going to go with all the same assumptions here. So 88%. Now the question is let's compare the 4% versus the 5%. So now if we go with the 5%, now you'll notice there's a 69% probability of success, so not nearly as good as 88, but not terrible. I mean keep in mind almost seven out of 10 times you've got plenty of money for 30 years and it's only showing you possibly running out of money here at age 84.

(12:12):

But again, there's a much higher likelihood that you'll have a lot more money. Okay, so that's the 5%, and then let me make the 5% over here on this side to make this even. And then let's look at the 6%. Whoops, not that one. Actually this is good. I'm showing you. So this is invested 6%, but assuming the same COLA, so 45% is not where we want to be, would not be comfortable with this, but at 6%, 6%, but now we're going to assume like we did just a moment ago that we're not going to increase the cost of living as fast as we saw right here. We're only going up at 1% a year.

(12:59):

Now the probability of successes are right about even 67 to 69. These are pretty close to the same. We're pretty close to the same. And again, that's what the spending looks like. So that question is again, which one is more appealing to you? Alright, so let's look at the confidence now on here with the 6%, with the 1% cola, and this shows us possibly running out of money at age 82, which would be 17 years down the line, but again, a much higher likelihood of still having plenty of money even at that time. Now, one option, and there's several different options here or strategies that can be incorporated in a successful retirement income plan. One option that I'm going to talk about here today besides just going with a more moderate risk type portfolio and being all invested in the market, is to carve off a portion of the portfolio to put into an annuity that provides a guaranteed income stream for life.

(14:06):

And this will really get at the heart of why I believe the 4% rule is just way too conservative and here is why. So again, let's move this back to 4%. This is if we have an all a portfolio that's in investment stocks and bonds and such. And then this is a portfolio where we have a combination of investments and also carving off a portion to the annuity. Now specifically what we did here with the annuity is took $509,554. And specifically that, or the reason for that number is I backed into how much income we could get from that. So in other words, if we put that amount into the annuity, that would buy $40,000 a year in benefits from the annuity going forward. So the remaining money, which is around what, 490,000 that's still invested in the market. So you'll see now that provides well even more stability.

(15:14):

I mean we're a hundred percent probability, which really is way too high. That just means we need to increase our spending because we're underspending. In this case, it wouldn't make sense to keep spending this low in this regard. So take a look right over here. And so again, this is why I'm telling you the 4% rule in my opinion is way too conservative. The first year alone, the annuity takes care of all of the income. Now, the next year we have to get a little bit of income here from the remaining investment portfolio, but it's a much, much smaller amount. And if you take a look right here, here's the withdrawal rate on the portfolio. So initially the total withdrawal rate, not the first year. The first year it's nothing, but the next year as we have to increase it goes to 0.1% and it doesn't even get past 1% until several years down the road.

(16:10):

And then the highest point here, it shows us 1.6% withdrawal rate. So I feel very, very confident with a 1.6% withdrawal rate on the portfolio. Again, this is because the annuity is providing that guaranteed income stream, so we need a lot less now coming from the portfolio. Again, we see that right here, 67% of the portfolio is stable, so it makes it so easy to do. Now let me say this is that I'm by no means saying that the annuity is the way to go. There's pros and cons to both options. In a nutshell though, here's the thing with an annuity, what it does is it provides you with that guarantee, provides more security. One of the upsides to it that I've heard clients say is that it gives me that license to spend. It's like Social Security or a pension. Each month you're getting that check coming in.

(17:09):

So I can spend it and I know I'm still getting another check. It all depends upon you. But I've had clients where we didn't have an annuity as a part of the mix. We're just taking it as a systematic withdrawal. And again, this often happens with people that have been frugal over the years that have done such a great job saving is they have a hard time becoming a spender. So now let's say that you want to spend $5,000 a month from your portfolio. Well now maybe you're thinking, well, maybe I can get by on $4,000 or $4,500. I'll just kind of save the difference there in the check. I feel like I'm uncomfortable taking from my portfolio. So there's some psychological advantages for sure. And also as far as just helping to minimize the risk, it does help to do that. It provides that guaranteed income just coming in without worrying about what's happening with the ups and downs of the investment portfolio.

(18:14):

So it takes a lot of stress off that for sure. Now, the downside to the annuity, the biggest downside is that if your investment portfolio, especially if it does very, very well, is that it's going to accumulate a lot more money down the road and you'll have a lot more money perhaps to spend in the future. And especially this could be important if let's say for instance, you've built up a nice size portfolio, maybe even more than you need and your withdrawal rate is quite low, maybe your withdrawal rate only needs to be about 3% and that more than satisfies your living expenses. And because you've accumulated so much and maybe you also have some goals, desires to have that money go on to the next generation. Perhaps you just want to invest more aggressively and maybe you can afford to do that and you go ahead and do that and then that money can continue on into the next generation.

(19:13):

So again, everybody's situation is different, which by the way, if you decide to incorporate an annuity at all, you could do it for different amounts. I just picked the one amount because I want to pick something that was about half and started with that $40,000 of the $40,000 a year, which was the 4% initial starting amount, but you could do it for less or whatever else. You typically can't do it for much more than this because there's limits on how much you can put as a portion of your overall liquid assets. So let's look at a few other things here and then we'll wrap it up. So let's look at the 5%. So again, the 5%, this is all invested in the markets, so an investment portfolio, and this is the 5% if also incorporating the annuity. So again, a much higher probability of success.

(20:14):

Now, 85, let's look at one other thing. Let's look at, so this is just that 6%. This is if it just invested in the markets, that more moderate risk portfolio we talked about. And this is the incorporating the annuity for this portion, that 509,000 that you'll see right there. And of course that higher probability of success. So again, no right or wrong answer here. It's all a matter of what is most comfortable for you. Really, all of this here today in looking at this, it's just meant kind of as a starting point so you can kind of get an idea of about how much might be possible. And I made everything very simplistic. I didn't even include on that analysis, obviously Social Security or any other income sources that might be available or taxes or anything else. We just want to look at what these withdrawal strategies might look like.

(21:13):

As I mentioned earlier, again, a lot of people won't live for 30 years in retirement. Many will live for less, 25 years, 20 years. So again, your situation here might be able to be adjusted even more. So you may be able to spend even more than this. And again, this is just at a high level. In reality, it's all about breaking down your expenses. This is why I always advocate for putting together a budget, identifying what your expenses are in retirement, what do you need, what do you want, how much does all that cost, and having a plan in order to accomplish that so that you feel confident so that you can spend your hard earned money. So hopefully this has been helpful. If it has, make sure you like and subscribe here and we'll see you soon.

Announcer (22:07):

Thanks for checking out today's episode. Please remember to like the video on YouTube and subscribe so you never miss an episode. If you're within five years of your desired retirement date, let's make sure you're on the right track with a free 20 minute consultation. Ryan can help answer your pressing questions such as, when can I retire? What are my options for healthcare in retirement? Should I adjust my investment strategy as I get older? And when should I collect Social Security? This consultation is the perfect starting point to craft a sound retirement plan. Schedule your call now by clicking the link in the description or visiting CravitzFinancial.com.