Why You Should Not Use The 4% Withdrawal Rule & What To Use Instead

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In this episode of Your Retirement Guide, George Jameson, CFP® and founder of Capital Wealth Group, explains why you shouldn't be using the 4% withdrawal rule in retirement and what you may want to use instead. 

 Welcome to "The Retirement Guide" Podcast! I'm your host George Jameson, owner of Capital Wealth Group, a Fee Only Advisory firm. Whether you’re nearing retirement or already retired, Join me each week as we explore the world of retirement planning and equip you with the knowledge and tools you need for a successful retirement.

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This is for education only.It is not tax, legal, or investment advice. Before  acting on any information consult your tax, legal, or investment advisor.

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Episode Transcript

George Jameson (00:00):
I am George Jameson, certified financial

(00:02):
planner and founder of CapitalWealth Group, located in
Columbia, South Carolina.
So let's get started.
Today we're tackling a popularyet increasingly controversial
topic in retirement planning.
The 4% withdrawal rule.
For decades, it's been touted asa safe, simple way to ensure
your savings last throughoutretirement.

(00:25):
You simply add up yourretirement savings, withdraw 4%
during your first year ofretirement, adjust that dollar
amount for inflation each yearafter, and you shouldn't run out
of money for at least 30 years.
It's very straightforward andeasy to follow.
And I still believe it's a goodplace to start to see if you're

(00:48):
on track for retirement.
However, relying on this rule asyour sole strategy can be a
significant gamble.
Why should you avoid it?
We don't know what the futureholds, and at best, it could
cause you to unnecessarilyconstrain your lifestyle or at

(01:09):
worst, lead you to depletingyour assets prematurely.
So what are the core problemswith the 4% rule in today's
environment?
First, let's talk about expectedfuture returns.
Many economists and financialinstitutions are now projecting
lower returns for both stocksand bonds over the next decade

(01:30):
or two compared to historicalaverages.
When your portfolio is growingat a slower pace, withdrawing a
fixed 4% may be fine, but whenthat amount is also increasing
with inflation, it puts a muchgreater strain on your
principle.
Think of it like drawing waterfrom a well, that's not being

(01:53):
replenished as quickly as itused to be.
Eventually it runs dry.
If future returns are indeedlower, a 4% withdrawal rate
might be more like a 5% or 6%effective rate in terms of
portfolio depletion,dramatically increasing the risk
of running outta money.

(02:14):
Second sequence of returns risk.
I've talked about this riskbefore, but it's very important.
This is a critical concept thatthe 4% rule does not adequately
address.
It's not just about averagereturns over 30 years when
you're taking money out eachyear.
It's about when those returnsoccur.

(02:37):
If you retire and immediatelyface a significant market
downturn, say a 20 or 30%prolonged drop in your portfolio
value, withdrawing, 4% of yourinitial balance, plus you add
inflation adjustments meansyou're selling more shares when
prices are low.

(02:58):
This creates permanent lossesand severely hampers your
portfolio's ability to recoverand grow.
When the market eventuallybounces back, the first few
years of retirement are crucial.
And a bad sequence of returnsearly on can cripple a portfolio
even if long-term averagereturns are decent.

(03:21):
The 4% rules fixed nature.
Makes it vulnerable to thesequence of returns risk.
And then third is longevityrisk.
People are living longer andyour retirement may last longer
than 30 years.
If you retired at age 65, thattakes you to age 95.
But what if you retired at age60 or 62, which a lot of my

(03:44):
clients do.
Or what if you or your spouselive well into your late
nineties or even past 100?
A plan designed for 30 years maynot be sufficient for a 35, 40,
or even 45 year retirement.
And then fourth inflationvariability.

(04:05):
The standard 4% rule applicationinvolves adjusting the initial
withdrawal amount by the rate ofinflation each year.
The original study did accountfor historical inflation.
However, we've recently seeninflation behave in ways many
haven't experienced in theiradult lives.
While the rule tries to accountfor this a period of sustained

(04:29):
high inflation, especially ifcoupled with low market returns
like stagflation can rapidlyerode the purchasing power over
your withdrawals and acceleratethe portfolio depletion.
And then fifth, the 4% rule is aone size fits all approach in a
world that demandspersonalization, it doesn't

(04:51):
consider your specific financialsituation, your unique
retirement goals, your risktolerance.
Your other potential incomesources like pensions or
part-time work, or yourhealthcare expenses, which can
rise greatly later inretirement.
Are you planning on leaving alegacy?

(05:12):
Do you have significanthealthcare concerns?
Are your spending needs likelyto decrease later in retirement
or increase due to travel andadventure early on in
retirement?
The 4% rule offers noflexibility for these very
personal, very realconsiderations.

(05:33):
It's a blunt instrument in asituation that calls for
surgical precision.
So if the 4% rule is not foryou.
What are some alternatives?
Well, it's not about findinganother magic number.
It's about adopting a moredynamic, flexible, and
personalized approach toretirement income planning.

(05:54):
This may involve variable ordynamic withdrawal strategies.
These strategies adjustwithdrawal amounts based on
portfolio performance.
For example, you may take outless after a down market year or
slightly more after a strongmarket year.
These are often called guardrailstrategies.

(06:15):
Guardrail strategies, forinstance, set upper and lower
bounds or bands for yourwithdrawal rate.
If your portfolio doesexceptionally well, you may take
out a bit more.
If it does poorly, you tightenyour belt.
Go check out my episodes on theguardrails and dynamic
withdrawal strategies.

(06:37):
The next approach you couldconsider would be a bucket
strategy.
I prefer the two bucketstrategy.
If you want to learn more aboutthe two bucket strategy, I have
at least two episodes on this aswell.
This involves segmenting yourassets into two buckets.
Bucket one would be your shortterm needs, let's say one to
three years.

(06:58):
It's usually invested in safeassets like money, market funds
and treasuries and so on.
And then bucket two is your midand long-term needs.
This bucket holds your stock andbond mix like a 60 40 investment
portfolio or whatever allocationfits your needs, risk tolerance,

(07:18):
et cetera.
Another option you could use iscalled Stress Testing.
This is where you're usingsophisticated financial planning
software like the one I use formy client to Right Capital.
We can model various withdrawalstrategies in various scenarios,
like poor market returns, highinflation, longer life
expectancy, different spendingpatterns, and so on, to see how

(07:42):
your plan holds up in thesescenarios.
And finally, I suggest no matterwhat strategy you use to do
regular reviews and adjustments,retirement isn't usually a sit
it and forget it affair.
Your plan needs to be reviewedregularly, at least annually or
when major life events occur,and then adjust it as needed.

(08:06):
The bottom line is that whilethe 4% rule is a valuable
starting point for discussion.
and provides a useful historicalbenchmark.
Its simplicity is its greatestweakness in a complex financial
world.
Relying solely on it is likenavigating a modern superhighway
using a map from the seventies.

(08:28):
You might eventually get to yourdestination, but you're just as
likely to get lost or find thatthe roads you are counting on no
longer exist.
Your retirement is too importantto leave to an outdated rule of
thumb, it requires a tailoredplan, one that reflects your
unique circumstances.

(08:49):
Adapts to changing marketconditions and is stress tested
for resilience.
That's it for today.
Happy planning and have a greatday.