Guideline four percent withdrawal rate

According to the American Institute for Economic Research, less than 20% of Americans between the ages of 45 and 74 is covered by a pension. This implies that the majority rely on defined contribution plans to fund retirement. It is crucial to find a sustainable withdrawal percentage to fund retirement. William Bengen started this quest in 1994 and proposed 4% as a guideline withdrawal rate. Calculation included taking 4% of retirement funds in the first year of retirement and adjusting amount for inflation for subsequent years. He found that if a retiree took out 4% from a portfolio equally split between stocks and bonds, the funds will last for at least 30 years. The 4% withdrawal rate rule is still used as a benchmark today.

Withdrawal 4 percent rule

Is the four percent rule appropriate?

Luke Delorme, Research Fellow at the American Institute for Economic Research, authored a study analyzing different retirement drawdown strategies. Asset allocation is kept constant at 50% stocks and 50% bonds. He used withdrawal percentages ranging from 2% to 7.5% and examined portfolio performance across different time periods with varying returns and inflation rates.

Withdrawal retirement balance

Source: American Institute for Economic Research

The study found that there is no particular strategy that wins in every return and inflation scenario. Strategies’ performance is highly dependent on market conditions. On retiree behavior, the study noted that if withdrawals are minimized during the first 5 to ten years of retirement, the likelihood of having enough funds to last a lifetime increases. If retirees increase their withdrawal percentages later in retirement, they will make their savings last longer. Finally, the study finds that a prudent starting withdrawal rate is 3%-5%. Retirees can adjust their withdrawal rate depending on market performance. For example, if market has muted returns for the first 2 years of retirements, being closer to a 3% withdrawal rate will be prudent. Withdrawal rates can increase with portfolio growth.

Withdrawal  drawdown

Source: American Institute for Economic Research

Withdrawal retirement