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As a financial planner in the early 90s, William “Bill” Bengen confronted a question that still puzzles aspiring retirees today — “When I get to retirement, how much can I spend?”
For Bengen’s baby boomer clients at the time, there was little expert guidance on the subject.
Bengen decided to investigate himself by running numbers with a spreadsheet and a data book.
In October 1994, he published his findings in the Journal of Financial Planning, and what is now known as the 4% withdrawal rule for retirement was born.
Today’s investors still confront the same retirement withdrawal dilemma, with the added risk of inflation, which Bengen calls the “greatest enemy of retirees.” Bengen created the 4% rule during a stretch of relatively low, stable inflation.
With his new book, “A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More,” Bengen is urging retirees to consider their entire financial circumstances when identifying their withdrawal strategy.
For some retirees, the good news is they may be able to withdraw more than 4%, according to Bengen.
How the 4% withdrawal rule works
Despite the 4% rule’s popularity, some investors get it wrong, Bengen said.
The strategy does not call for a 4% withdrawal rate for every year in retirement.
Instead, the 4% withdrawal rate applies only to the first year. That rate is then adjusted for subsequent years to account for inflation, much like Social Security benefits get an annual cost-of-living adjustment, according to Bengen.
That COLA withdrawal approach is not the only strategy. Some people may choose to withdraw a fixed percentage or withdrawal amount. Others may prefer to take more money out early in retirement and cut back later, Bengen said.
“There’s so many ways you can do it,” Bengen said.
However, all retirees would benefit from keeping all of their financial circumstances in mind when identifying their personal strategy, he said.
Those factors include the length of their planning horizon, whether they have taxable or non-taxable assets, whether they want to leave money to heirs, how their assets are allocated, how often they plan to rebalance their portfolios, the size of their returns and when they plan to make their withdrawals, according to Bengen.
When retirees may be able to withdraw more
In the 90s, Bengen’s research pointed to a maximum safe withdrawal rate of 4.15% for the first year of retirement.
That rate was based on several portfolio assumptions:
- money would be held in a tax-advantaged account such as an individual retirement account;
- a 30-year time horizon that would end in a zero balance;
- a fixed allocation of 60% stocks and 40% bonds; and
- annual rebalancing that would reset the portfolio back to its target weighting
Today, the maximum safe withdrawal rate is 4.7%, according to Bengen’s calculations.
Bengen calls that 4.7% rate “Universal Safemax” — the historical maximum safe withdrawal rate for all retirees.
Consequently, retirees who use a 4.7% withdrawal rate may be sacrificing on average about 35% per year in withdrawals, a “considerable reduction in lifestyle,” Bengen writes in his book.
Notably, Bengen’s historical data shows some retirees may be able to take those withdrawals even higher, with the average Safemax rate at about 7.1%.
To be sure, because that 4.7% maximum safe withdrawal rate is based on past performance, it is not guaranteed that it will hold true for future retirees. Whether new retirees should rethink that withdrawal rate has been a subject of debate among experts.
Moreover, if retirees expect to leave money to heirs, they will have to cut their withdrawal rates accordingly, Bengen said.
How retirees can confront looming inflation risks
In his book, Bengen provides tables to help prospective retirees roughly gauge their own personal maximum safe withdrawal rate.
To gauge their “Safemax,” retirees need to estimate their average inflation rate for their early retirement years as well as the expected Shiller CAPE (or cyclically adjusted price-to-earnings) ratio, a measure of stock market valuation that takes inflation-adjusted earnings into account.
A bear market — where stocks fall more than 20% — or high inflation early in retirement can affect the longevity of retirement portfolios, according to Bengen.
Higher inflation during retirement can be “scary,” Bengen said. While the record 8.7% Social Security cost-of-living adjustment that went into effect for 2023 may have seemed nice, the extra money was mostly claimed by higher prices, he said.
Retirees should be prepared to deal with inflation “immediately and strongly if it occurs,” Bengen said. For most people, that comes down to reducing their expenditures, he said.
Nearly two-thirds of retirees — 63% — worry that tariffs will push inflation higher than what Social Security cost-of-living adjustments may cover, according to a June Nationwide Retirement Institute survey.
While the latest government data shows there has been an uptick in inflation, with the Consumer Price Index at 2.7% on a 12-month basis as of July, that is still lower than the 9% rate that inflation gauge posted in June 2022.
