Does the 4% Retirement Withdrawal Rule Work with Higher Inflation?

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The cost of living continues to rise – at the fastest pace in decades. If you want to retire in the coming years, you might be wondering about the impact of inflation on the longevity of your portfolio.

Can your portfolio survive higher inflation?

When it comes to the 4% rule, a reader wonders, does the 4% rule work with higher inflation (like what’s happening right now)?

We have that answer and more for you to consider in today’s post!

Does the 4% rule make retirement sense?

To start off with, the 4% rule remains a decent starting point for some quick math for any retirement readiness – but that’s about it.

Simply put:

  • If you want to spend $40,000 or so per year in retirement, you’ll need a portfolio of $1 million to start with.
  • If you want to spend $60,000 per year, you’ll need about $1.5 million.
  • If you want to spend $80,000 per year, you’ll need about $2 million.

And so on…

To recap, the “4% rule” says that you can safely withdraw 4% of your savings/portfolio each year (and increase it every year by the rate of inflation) from the time you retire and have a high probability you’ll never run out of money over 30 years.

Some things to keep in mind when you read this:

1. This ‘rule’ originated from a paper written in the mid-1990s by a financial planner in the U.S. who looked at rolling 30-year periods of a 50% equity/50% fixed income asset allocation. His name was Bill Bengen.

4% rule

2. This rule was developed almost 30-years ago. A lot has changed since then…

3. The study was designed to answer the question: “How much can I safely withdraw from my retirement savings each year and have my nest egg last for the duration of my retirement?” Little else.

That means this rule does not take into account:

  • Will you (or your spouse) have a defined benefit pension plan?
  • Will you downsize your home or sell your home to support retirement spending needs?
  • Will your income needs be variable or change over time?
  • Will you continue to earn some form of income in your senior years or will you consider part-time work in semi-retirement?
  • And that list goes on too…

4. Finally, the study assumed (at the time) most retirees would retire around age 60. Therefore, a “good retirement” would be ~30 years thereafter; what is the safe withdrawal rate to make it through retirement until death. This study hardly makes sense for any early retiree (ie. retiree with longer than a 30 year timetime).

In fact, we shared some important math on that here:  The 4% rule actually doesn’t make any sense for early retirement.

So, should we all rethink the 4% rule?

We believe so.

While the 4% rule is a decent starting point for any back-of-the-napkin math for retirement, it is hardly a retirement drawdown rate to trust.  In fact, it doesn’t make sense for these key reasons:

1. It might be too conservative.

Yup.

Depending on your time horizon, even if it is 30-years, remember depending on stock returns…the 4% rule was founded on the worst-case scenario: a withdrawal rate of about 4.15% and rounded down to 4%.

That withdrawal rate worked “in the worst historical market sequence…”.

Mapped forward by guru Michael Kitces, even if you retired on the eve of the GFC (Great Financial Crisis 2008-2009), thanks to the recent 10-year+ bull market that followed you’d still be WAY ahead.

In fact, Michael and his team have done more work in recent years. They’ve replicated the Bengen study. In a whopping 50% of the time, using the 4% safe withdrawal rate you will finish not just WAY ahead but with almost X3 your wealth on top of a lifetime of spending using the 4% rule.

4% rule Kitces

So, the 4% rule actually is very conservative based on historical data and likely future returns.

2. The 4% rule is based on an outdated model.

Yup, and this is very important people…

Recall Bengen’s study was published decades ago looking at rolling 30-year periods of a 50% equity/50% fixed income asset allocation.

Any idea of what bond returns were decades ago? 

Much higher!

So, Bengen’s study and therefore rule was built around a time when bonds were actually doing bond-like things: paying out a modest interest payment.

That’s hardly the case right now.

Canadians have been spoiled, in recent years, and those days might be coming to an end:

  1. Prolonged, ultra-low interest rates, and
  2. A significantly long, low period of inflation.

We believe at Cashflows & Portfolios, owning a large % of bonds in your portfolio is going to get eaten alive…by inflation.

Keeping a smaller allocation in bonds in your portfolio does make sense depending on your investing needs:

  1. As a hedge for/to ride out stock market volatility.
  2. To help rebalance your portfolio (with equities) a few times per year, and/or
  3. To cash-in when spending is essential since cash and cashflow is king for near-term spending.

Does the 4% rule work with higher inflation?

So, you should know by now that the infamous 4% rule is a quick starting point for sustainable retirement targets and withdrawals but hardly gospel.

With that in mind, we wanted to answer this recent reader question:

Does the 4% rule work with higher inflation?

Here are our assumptions.

Christina, (we changed her name), shared the following:

  • Currently single, female, age 65, living in rural Ontario.
  • Christina is already retired (recently), wondering about this question above.
  • She lives very modestly, owns a small 2-bedroom home. She spends on average $40,000 per year after-tax but is wondering about the impacts of higher inflation over the coming decades.
  • She hopes to live to age 95 – so our projections will include that longevity.
  • Christina has no debt and has no intention to go into debt, with higher borrowing costs coming…
  • We’ll assume a modest 70% of Canada Pension Plan (CPP) benefits at age 65 – but we’ll defer those benefits for her to age 70.
  • Christina will have 100% OAS benefits.
  • She does not have any pension plan, but, she has been a very good saver and investor over the last 30 years. She has close to $1 million in her RRSP thanks to years of compounding power.
  • She has no LIRA (Locked-In Retirement Account) and no non-registered investment account to speak of, beyond her $20,000 emergency fund in cash.
  • Christina took full use of her good salary before retirement to max out her Tax-Free Savings Account (TFSA), her TFSA balance as of today is $125,000.
  • Her home/primary residence is worth $700,000 on a decent parcel of land. She has no intention to sell.
  • Assuming a pre-inflation return across her accounts of 5%, with increasing withdrawals to account for higher inflation.

What are the results – with long-term inflation 3.5%?

At 3.5% inflation, and providing the assumptions above are met, the calculations show that spending $40k/year after-tax (adjusted to inflation) is fairly conservative and results in a final estate of $3.2M after-tax at age 95.  Running further calculations, it shows that Christina can spend more than her desired $40k/year.  How much more?  About $57k/year after-tax increasing with inflation annually while still leaving her real estate to her final estate.

What are the results – if inflation is sustained at 4.5%?

At 4.5% inflation, and providing the assumptions above are met, the calculations show that spending $40k/year after-tax (adjusted to inflation) is still fairly conservative and results in a final estate of $3M after-tax at age 95.  Running further calculations, it shows that Christina can spend more than her desired $40k/year.  How much more?  About $52.7k/year after-tax increasing with inflation annually while still leaving her real estate to her final estate.

Finally, what are the results – if inflation runs hotter at even 5.5% long-term?

Even at 5.5% inflation, and providing the assumptions above are met, the calculations show that spending $40k/year after-tax (adjusted to inflation) still works and results in a final estate of $2.7M after-tax at age 95.  Running further calculations, it shows that Christina can spend more than her desired $40k/year.  How much more?  About $48.8k/year after-tax increasing with inflation annually while still leaving her real estate to her final estate.

Does the 4% rule work with higher inflation summary

From today’s post, we hope you can see that depending on your time horizon, even if it is 30-years or even up to 40 years, in retirement thanks to our reader question, the 4% rule can be rather conservative for high-level retirement planning.  Caveat – the longer your retirement (ie. early retirees), the riskier the 4% rule is!

Your other takeaway should be: Christina’s saving grace with higher inflation is really her modest spending needs.  In this case, taking boosted CPP at 70 (OAS at 65) and both payments increasing with inflation really makes a difference. If you aspire to spend more, during periods of higher inflation, the reality is that you’ll need to save more (or hope for higher returns!).

If you are closing in on retirement and worried about the impact of inflation,  we can help you with a financial drawdown plan to combat inflation in some personal retirement projections reports.

We answer client questions like:

  • Can I meet my retirement spending goals during x% inflation and x% return?
  • What registered accounts do I draw down first (and how much) for maximum tax efficiency?
  • How much income will my investments generate to cover my needs?
  • What is the most that I can spend annually during retirement?
  • How long will my portfolio last?
  • Is it more beneficial to draw down non-registered money before RRSPs and TFSAs?
  • Should I take CPP at age 60, 65 or 70? Why?
  • And much, much more…
Knowing how to demystify the retirement income puzzle (ie. RRSP/RRIF, TFSA, taxable accounts, CPP, OAS, Defined benefit pensions, LIRAs, inheritance..) is not trivial work but it’s absolutely something we can help with.
If you need some help solving your retirement decumulation puzzle (i.e., how to efficiently withdraw from your retirement accounts), or figuring out if you have enough saved from any portfolio you’ve constructed we’re here to help answer those questions and more!

If you are interested in obtaining private projections for your financial scenario, check out all the details here!

Thanks for your ongoing readership and for sharing this site with others – our site is growing thanks to you!!

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4 thoughts on “Does the 4% Retirement Withdrawal Rule Work with Higher Inflation?”

  1. An excellent look at how the 4% rule fits into a “normal” retirement. Thanks

    In the example, what was the portfolio’s assumed rate of return, and did it increase inline with inflation?

    Reply
    • Thanks Bob!
      In our case study, we assumed the portfolio would grow by only 5%, with increasing withdrawals to account for higher inflation. Inflation was 3.5% or 4.5% or 5.5% in our study.
      CAP

      Reply
        • Yup, but again, assumes CPP and OAS are also indexed to that point of inflation without fail; no government changes to those programs; and 5% is your return every single, year, without fail – so 5% on average is fine over decades (which is why we picked it, seems very reasonable) but always earning 5% per year, every year, with no deviation, is not very likely.

          Reply

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