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The four per cent rule: Don't run out of money in retirement

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THE four per cent rule was created by retired financial planning practitioner William Bengen in 1994. He has since revised the rule to the 4.5 per cent rule. William Bengen is the author of the book Conserving Clients Portfolio During Retirement .

The popular four per cent rule speaks to a safe annual rate at which a retiree should withdraw funds from an investment portfolio without running out of money during retirement. Bengen studied the spending strategy of retirees and introduced the four per cent rule.

According to the American Association of Individual Investors (AAII) 2018 journal, depending on how many years a retiree plans to spend in retirement, William Bengen recommended a graded withdrawal rate for different time horizons; for example, for a retirement horizon of 25 years, the withdrawal rate is 4.7 per cent and for a 20 year horizon it is 5.2 per cent. Bengen’s four per cent rule formula was established to help retirees to maintain the same standard of living they had prior to retirement without running out of money.

Using the four per cent rule, a retiree who makes the first four per cent withdrawal of funds in the first year will adjust subsequent yearly withdrawals by the annual rate of inflation. This is important as the average retiree is expected to spend up to 30 years in retirement and the goal is to ensure that the retiree doesn’t run out of money. The retirees’ investment portfolios are expected to provide constant streams of income throughout retirement so that they can maintain the standard of living that existed prior to retirement. Expenses such as long-term health care, medical bills, and unforeseen expenses increase with age, therefore, inflation is a real threat to the purchasing power of retirement funds.

Let’s examine how the four per cent rule works. A new retiree has a total of $3,000,000 in an investment fund for retirement. In the first year of retirement, the retiree can withdraw up to four per cent of the principal. This means the retiree can spend $120,000 in the first year of retirement. The next year, the retiree makes an adjustment for inflation. So, if the rate of inflation is six per cent ($120,000 x 6 per cent) he/she can withdraw $127,200. Inflation determines the amount that is withdrawn each year. It is important to note that the objective of the inflation adjustment is to ensure the purchasing power of funds withdrawn. Bengen’s four per cent rule was based on the assumption that the asset allocation of a retiree’s investment portfolio should consist of 50 per cent bonds and 50 per cent stocks. It was proven that with a four per cent withdrawal rate, the investment lasted at least 35 years. If wealth creation is the retiree’s goal it is recommended that the stock allocation be increased from 50 per cent to 75 per cent.

Is the four per cent rule still reliable?

The four per cent rule is likely to help your retirement investment last a lifetime, but there is no guarantee as the rule is based on historic performances and the future is unpredictable. It is necessary for investment strategies to be dynamic, as market conditions will change.

When there is an extended downturn in the markets, the four per cent rule may not work due to decline in stock values. The four per cent rule works best for retirees who are disciplined and are committed to the investment strategy. Any deviation can result in depletion of capital and impede earnings from compound interest. Research shows that the four per cent rule has proven to be effective during times of great difficulties.

An alternative to the four per cent rule is that one should work until age 70. Delaying retirement means additional income, which would allow your money to last even longer in retirement. It provides the opportunity to pay off debts or mortgages, as well as provide for increase savings and less spending during retirement. Another alternative to the four per cent rule is the 15/30 rule, which recommends that pre-retirees who have 15 years to retirement should have at least 50 per cent of their investments in stocks. This will give much-needed purchasing power to investments in retirement. Investing in stocks over the long term adds purchasing power to your money and beats inflation.

The four per cent rule was developed to help retirees navigate the worst economic conditions. Retirees should seek the assistance of licensed financial advisors who can assist them in adopting investment strategies that are relevant to their particular goals in a changing economic environment. The bottom line for retirees is to ensure that you don’t run out of money when you need it most. Frequent withdrawals early in retirement can prove detrimental in the latter years. On the other hand, too few withdrawals in retirement can deprive you from enjoying the fruits of your labour. Managing spending in retirement is a balancing act.

Your money should outlive you.

Grace G McLean is a financial advisor at BPM Financial Limited. Contact her at gmclean@bpmfinancial or visit She is also a podcaster for Living Above Self (