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I Don't Like the 4% Rule

Federal Employees

What is the 4% rule, you ask?

Generally speaking, the 4% rule is a guideline that allows for retirees to withdraw 4% of the balance of their investments annually in order to sustain a steady income throughout the entirety of their retirement.

It's not that I don't like it, but I believe there are a few flaws with the 4% rule. Namely, that retirement spending isn’t static.

Most retirement withdrawal studies include two rules of thumb. The first is that you start by withdrawing a specific percentage (i.e., 4%) of your balance. The second is that the withdrawal amount is increased by approximately 3% each year to account for inflation. This is one of my favorite studies about retirement withdrawals.

Spending the same amount of money every year in retirement isn’t very practical. A retiree’s fixed expenses should be somewhat static. Things like rent, electric bills, real estate taxes, insurance, and food costs remain relatively steady except for increases due to inflation. Discretionary expenses, however, can vary widely.

My two issues with a static withdrawal rate are:

  1. Delaying Social Security until Full Retirement Age (FRA), or even later can reduce your income early in retirement.
  2. Spending changes in retirement

Delaying Social Security

Many retirees choose to delay collecting Social Security past the age of 62. The two biggest reasons are to receive a larger benefit and potentially have a larger widow/widower’s benefit; however, this creates a gap in income. If someone retires at minimum retirement age (MRA), they will receive the Special Retirement Supplement until they turn 62, which means some retirees may see more than a $20,000 loss in income between the age of 62 and when they start collecting Social Security.

How will the income gap be supplemented? It will need to come from investments unless the retiree wants to go back to work (not a preferable option).

In this scenario, the retiree who was taking a 4% withdrawal would be forced to increase their withdrawal for up to eight years (if delaying Social Security until age 70). An increase in spending like this can damage a retiree’s withdrawal plan of 4% annually.

Delaying Social Security can be a good strategy but it’s nearly impossible with a static withdrawal rate.  

Spending Changes in Retirement

Anecdotally, one out of every two people I counsel when preparing for retirement wants to spend more money earlier in their retirement. They want to travel and spend time vacationing in the first 10 to 15 years of retirement. Again, this is feasible yet difficult to implement with a static withdrawal rule.

You don’t have to spend the same percentage every year!

The best way to approach a retirement with varying amounts of spending is to simply spend some time evaluating different retirement cash flow analyses. Here are the two examples I typically address for clients:

  • increased withdrawals from age 62 until filing for Social Security
  • additional spending of $2,000 (example $ amount) a month for the first 10+ years of retirement

Each of these cash flow scenarios would provide a specific plan for what to do in retirement, such as withdrawing an extra $24,000 a year from TSP between the ages of 62 and 67. This doesn’t mean asset levels may not decrease during that time, but it won’t come as a surprise if it does happen, and it won’t jeopardize plans for future income. Keep in mind that your investments are there for your enjoyment in retirement and a decline isn’t always a bad thing, especially if it’s planned for.

If you made it this far, I hope your takeaway is that retirement planning can be very flexible. You just need to plan for it!

If you find yourself wondering how much money to withdraw, when to take withdrawals or how much you will pay in taxes, I’d be happy to schedule an introductory call to discuss how we can be a partner on your retirement journey.

Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees. 


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