Safe withdrawal rate

In the method Bengen's study used, the rate sets the first year only. A 4% rate on a $1,000,000 portfolio is $40,000 in year one; from then on the dollar amount is adjusted for inflation, whatever the portfolio does. The rate is not taken again from the new balance each year.

“Safe” is defined against a record, not promised. In “Determining Withdrawal Rates Using Historical Data” (Journal of Financial Planning, October 1994), Bengen used the Ibbotson series for US common stocks, intermediate-term Treasury notes and inflation, starting a hypothetical retirement on January 1 of 1926, 1927 and each year through 1976. The portfolio was rebalanced continually, and the assets were assumed to sit in tax-deferred accounts.

Bengen reported that in the study, with a 50/50 portfolio, a 4% first-year withdrawal, adjusted for inflation each year after, had not exhausted a portfolio before 33 years in any period he tested. A 4.25% rate, he wrote, “could exhaust a portfolio in as little as 28 years, were past conditions to repeat themselves”, and he reported that a 3% rate lasted at least 50 years in every period of the study. Assuming a minimum requirement of 30 years, he wrote that a 4% first-year withdrawal followed by inflation-adjusted withdrawals “should be safe”.

A portfolio holds $1,000,000 on the first day of retirement. At a 4% first-year rate, the first year's withdrawal is $40,000. Inflation runs 3% that year, so the second year's withdrawal is $41,200.

If the portfolio has fallen to $800,000 by the start of year two, $41,200 is 5.15% of it. The dollar amount follows inflation; the share of the portfolio it takes moves with the market.

Read the other way, a $40,000 first-year withdrawal at 4% corresponds to a portfolio of $40,000 ÷ 0.04, which is 25 times the withdrawal: $1,000,000.

Portfolio at retirement

$1,000,000

First-year rate

× 4%

First-year withdrawal

$40,000

Inflation in year one

× 1.03

Second-year withdrawal

$41,200

The rate turns a portfolio into a spending figure, or a spending figure into a portfolio: dividing by 4% is multiplying by 25.

The study's 4% result belongs to the study's inputs: returns data from Ibbotson's 1992 yearbook starting in 1926, a 50/50 portfolio of stocks and Treasury notes, a 30-year minimum, withdrawals adjusted for inflation, and assets held in tax-deferred accounts. A different horizon, mix or record of returns can give a different rate.

The Taiga Finance Retirement savings planner shows the rate inside its “Money lasts” figure. Opened, the working lists the annual spending, the balance at the retirement age and, as the “First-year withdrawal rate”, the plan's annual spending before Social Security divided by the projected balance at the first retirement age. Its caveat says the 4% rule is a reference, not a target.

The planner's “At retirement” figure reads the projected balance at the retirement age against the balance the plan needs there: the smallest balance from which the plan's own spending, Social Security included, lasts to the plan's end.