You’re ready to retire. The big question is: How much can you actually spend? It’s a question that stumped many people in the early 90s, including financial planner William “Bill” Bengen. With little guidance available for his baby boomer clients, Bengen decided to figure it out himself, and his research eventually led to the now-famous 4% withdrawal rule.
Bengen published his findings in the Journal of Financial Planning back in 1994, and the rule has since become a cornerstone of retirement planning. But many people still misunderstand how it works. The strategy doesn’t suggest withdrawing 4% every single year. Instead, you’re meant to withdraw 4% of your total retirement savings in the very first year. After that, you adjust the withdrawal amount each year to account for inflation. It’s similar to the way Social Security benefits get a cost-of-living adjustment.
While the 4% rule is a popular starting point, it’s not the only way to approach retirement spending. Some people might choose a fixed percentage or a set dollar amount each year, while others may opt to spend more early in retirement and less later on. The most important thing, Bengen says, is to consider your entire financial situation before you commit to a strategy. Things like how long you expect to live, whether you have taxable accounts, your investment allocation, and whether you plan to leave money to heirs should all factor into your decision.
You Might Be Able to Spend More
Back in the 90s, Bengen’s research pointed to a maximum safe withdrawal rate of 4.15% for the first year of retirement. This was based on a few assumptions: a 30-year retirement horizon, a 60% stock/40% bond portfolio that was rebalanced annually, and a tax-advantaged account like an IRA.
Today, Bengen’s latest calculations suggest that the maximum safe withdrawal rate is actually 4.7%, which he calls “Universal Safemax.” He notes that using this lower rate could mean you’re missing out on a lot of money you could have spent, potentially reducing your lifestyle in retirement. In fact, his historical data shows that the average safe withdrawal rate is closer to 7.1%.
However, it’s important to remember that these numbers are based on past performance, and there’s no guarantee they’ll hold up for future retirees. If you’re hoping to leave money to your heirs, you’ll also need to lower your withdrawal rate accordingly.
Taming the Inflation Dragon
Bengen refers to inflation as “the greatest enemy of retirees.” The original 4% rule was created during a period of relatively low and stable inflation, which isn’t the case for today’s retirees. Bengen’s new book, “A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More,” provides tables to help people estimate their own personal maximum safe withdrawal rate.
To get a sense of your “Safemax,” you’ll need to consider your expected inflation rate in your early retirement years, as well as the Shiller CAPE ratio, which is a way of valuing the stock market. A bear market or high inflation early in retirement can significantly affect how long your money lasts.
While a high Social Security cost-of-living adjustment might seem like a win, Bengen warns that it’s often canceled out by rising prices. According to him, retirees must be prepared to handle inflation “immediately and strongly.” For most people, that means being willing to reduce their spending to protect their portfolio. With many retirees concerned about inflation, it’s a good reminder that staying flexible with your spending is a crucial part of a successful retirement plan.