Dick and Jane have left the premises because they have better things to do. But Syd is still here and in light of this blog’s spirited discussion of the 4% rule (or 3% rule, whichever applies to you), I wanted to illustrate how distributions work over the lifetime of your retirement when you use the 4% rule.
This particular retiree, Average Joe, actually winds up doing better than the worst-case scenario that drives the 3% rule—the result is that he dies with a little money left over, based on the facts I create. (I could have chosen facts that would result in a better or worse outcome, it doesn’t matter, I’m just trying to illustrate how the withdrawals will work for Joe.)
No one will ever experience a steady growth of exactly the same earnings and inflation rates each year, but I wanted to provide a simple example to show you generally how your retirement withdrawals might look 10, 20, and 30 years down the line when you use the 4% rule:
Joe starts with $1 million. He experiences exactly a 3.5% inflation rate every year of his retirement, and also a steady 5% return every year of his retirement. (Remember the 4% rule is that Joe withdraws 4% of his nest egg in the first year and then adjust that dollar amount by the inflation rate each year. For Joe that’s a 3.5% inflation rate each and every year.) Here’s how his distribution history would look:
Here are the two things I'd like to point out:
1) In the early years Joe's assets keep growing from year to year. He begins at $1 million and because his earnings are larger than his withdrawals, his nest egg grows to $1.049 million by Year 9.
2) After that, the inflation adjusted amount of his withdrawals becomes larger than the growth his nest egg generates. Eventually his nest egg declines to $280,000.
3) The percentage of his nest egg (final column) that he is actually drawing each year is only near 4% in the early years. As inflation increases the withdrawal amount it represents a larger and larger share of his nest egg balance. By year 15 he's actually withdrawing over 6% of his nest egg, and by year 25, nearly 13%. If he lives long enough, his final withdrawal would be 100% of his assets and he would die with nothing.
No matter what facts you assume, this will always happen, i.e. that when using a flat starting rate, say 3% or 4%, that you adjust for inflation each year, your nest egg will grow for some period in the early years and shrink after that, down to nothing depending on how long you live.
If you tried to keep your actual withdrawal rate at 4% for a long period of time, you would find that a) you can’t buy as much as you used to, and b) you might actually die with a bunch of with money left over. Which might be ok for those of you with heirs, but I’m trying to bounce that last check.
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