If you’ve read much about retirement planning, you’ve probably encountered the “4% rule,” which suggests that investors withdraw no more than 4% of their portfolio per year during the early stages of retirement.
The 4% rule is the result of various studies (most famously this one), which showed that using a withdrawal rate much higher than 4% leads to an undesirably-high probability of running out of money over a 30-year retirement — the underlying assumption being that 30 years is a conservative (on the high end) estimate of how long retirement might last.
But just how conservative is that 30-year assumption? For a 65-year-old or a 65-year-old couple, it turns out it’s quite conservative. According to a handy calculator from Vanguard (which uses data from the Society of Actuaries):
- A male age 65 has just shy of a 6% chance of living another 30 years,
- A female age 65 has a 13% chance of living another 30 years, and
- A male/female couple age 65 has an 18% chance that one of the spouses will live another 30 years.
So, for example, for a spending strategy that has a 20% historical failure rate over 30-year periods, the historical chance that an actual 65-year-old married couple would have run out of money during retirement is actually significantly below 20%. To run out of money, they’d need to have a poor-returns outcome and a living-longer-than-average outcome.
Incorporating Life Expectancy Data
Fellow blogger Wade Pfau recently ran the numbers and put together some handy charts to show the historical probability of running out of money (given various asset allocations and withdrawal rates) for a 65 year-old couple using actual life expectancies rather than an assumption that they’ll automatically live for 30 more years.
Of course, as with any study based on historical data, it’s only useful as a predictor to the extent that future returns look like past returns. And many experts believe that stock returns going forward are unlikely to be as high as those of the previous century.
Still, I find the results at least a little encouraging.
For example, according to Pfau’s research, a married couple both age 65 using a 4% withdrawal rate has a less than 10% historical probability of running out of money at most asset allocations. (Interestingly, at a 4% withdrawal rate, the failure rate is barely affected by asset allocation. Portfolios of 30% stocks, 70% stocks, and everywhere in between have nearly identical failure rates.)
Even if you bump the withdrawal rate up to 5%, the probability of running out of money doesn’t exceed 20% for most moderate asset allocations.
Admittedly, the idea that we might not live as long as we’d planned isn’t exactly an overwhelmingly positive message. But at least we might not have to be as stingy with our money as we’re often told to be.