The 4% retirement rule succeeds over 90% of the time across 30 years, while the 5% rule fails 3 out of every 10 retirees before time runs out.
On a $750,000 portfolio, the 5% rule delivers $7,500 more annually, but early market downturns hit harder since more shares sell at depressed prices.
The 5% rule works best as a temporary bridge until Social Security or a pension kicks in, then dropping to 4% becomes the smarter move.
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Even if you are not at all familiar with retirement planning, there is a good chance you have heard about the 4% retirement rule, which has been the standard in retirement planning for the last three decades. The problem is that more and more retirees are sitting down with their actual numbers and finding that the 4% number doesn't stretch as far as they might want to go. This is the opening the 5% safe withdrawal rate needs to begin a conversation.
However, a growing number of retirees are looking at their savings, re-running the numbers on paper, and really thinking through whether the 4% number gives them enough to live on. This is where the 5% safe withdrawal rule enters the conversation.
On a $750,000 portfolio, the math is pretty simple and even more straightforward. Using the standard 4% rule, you'll receive around $30,000 per year in income. At 5%, the income jumps to $37,500 annually, a difference of $7,500 annually. This is a notable difference, and for many retirees, this extra money is the difference between an easy or hard retirement.
Ultimately, the question worth asking is what pulling that extra $7,500 actually costs over time.
If you've saved over $1,000,000, this guide is for you. The last thing you want in retirement is to run out of money, you want your money to generate lasting income while you enjoy your life.
Now you can learn the strategies wealthy retirees use to fund their retirement with The Definitive Guide to Retirement Income from Fisher Investments. Download the guide today! (sponsor)
The 4% rule was built with one goal in mind and that was to survive a 30-year retirement no matter how the market performed, most importantly including down years. It has a success rate over 90% for a 30-year horizon with a balanced portfolio. This is far from a guarantee, but it's about as close to one as retirement math can get.
The 5% rule might be gaining steam in financial circles, but not always for the better. History shows its 30-year success rate is only 71% of all retirees making it before running out of money. This means that 3 out of every 10 retirees who adhere to the 5% rule will run out of money before time is up. Under normal market conditions, this is a pretty uncomfortable scenario, but if a downturn hits in the first few years of retirement, things can get dangerous, and fast.
Stretch the horizon out to 40 years, and the success rate will drop further. For a healthy 65-year-old with 25-30 years realistically ahead of them, this isn't a margin they can feel very confident about.
The most important thing to remember is the 5% strategy works best as a temporary bridge and not necessarily as a permanent rule. Until Social Security or a pension kicks in, taking out a 5% withdrawal makes sense as you need additional money to live, but once those guaranteed income sources kick in, dropping down to 4% can be the smarter move.
The pressure on your portfolio will ease in a significant way once a guaranteed income source picks up part of the load. Spending flexibility is the other scenario where 5% can hold up, but the flexibility has to actually exist in the budget.
A fixed withdrawal rate doesn't negotiate based on market conditions as it goes out the same month, like clockwork, no matter if the market is up or down. The challenge is that things like healthcare have a way of eating through whatever cushion a retiree thought they would have built in. The retiree who can pull from cash instead of selling shares during a bad market is playing a different game than other retirees.
It's okay to think twice about cutting back spending when you're in a good market year, but when a downturn arrives, and it will, budgets are never as flexible as retirees hoped they would be.
When you try and compare these two withdrawal rates against each other, you quickly see that both rules share the same sequence-of-returns risk, but it's the 5% rule that has the thinner cushion overall. Early retirement market drops will absolutely hurt the 5% retiree more because they are liquidating their portfolio at depressed prices to try and fund the same lifestyle as the retiree liquidating at 4%.
When shares are sold, no matter the withdrawal rate, they won't participate in any market recovery, so the portfolio is climbing back from a smaller base while still being forced to handle the full withdrawal burden. The biggest red flag is that the gap between where the portfolio should be and where it is actually is rarely closed once this door opens.
Average return projections can look fine over 30 years
For any retiree who is trying to think through what a 25 to 30-year retirement window could look like, the 4% safe withdrawal rate is the defensible choice, and historical data backs up this thinking. More importantly, the gap between a 90% success rate and a 71% success rate is not a minor difference; it's 3 people who are running out of money out of every 10.
There is a definite argument here that 5% withdrawal rates have legitimate use cases, but they are very specific and not as general as the 4% rule. This applies mostly to people who have heavy guaranteed income from places like Social Security or a pension, where there is less pressure to withdraw more money because the portfolio isn't carrying all of the financial pressure.
Another scenario where the 5% rate can work is with spending flexibility, but it has to be someone who is really flexible and not just okay with it in theory. Most people think and say they can cut back when necessary, but when push comes to shove, and it really has to happen, their budget can't bend as far as they hoped.
An extra $7,500 per year does feel pretty significant between the two withdrawal rates at the start of retirement, but the problem is that the cost of this extra withdrawal tends to show up in ways that could be concerning depending on market cycles.
If you've saved over $1,000,000, this guide is for you. The last thing you want in retirement is to run out of money, you want your money to generate lasting income while you enjoy your life.
Now you can learn the strategies wealthy retirees use to fund their retirement with The Definitive Guide to Retirement Income from Fisher Investments. Download the guide today! (sponsor)
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