5 Ways to Cheat the 4 Percent Withdrawal Rule

In some cases you can safely withdraw more than 4 percent of your retirement portfolio.

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This past week I had the pleasure of interviewing Rick Ferri on my weekly podcast show. Ferri is the founder of Portfolio Solutions, which manages $1.3 billion in assets. He’s also published some excellent books on investing, with “All About Asset Allocation” on the top of my list.

During the interview we discussed safe withdrawal rates from retirement savings. One observation Ferri made was that retirees spend less later in retirement than they do when they first retire. His observation, which rings true to me, motivated me to dig into the generally accepted 4 percent withdrawal rate rule. The rule states that a retiree can withdrawal 4 percent from his or her nest egg the first year of retirement, and then the same amount adjusted for inflation each year, without running out of money for at least 30 years.

But the 4 percent rule presents a problem for many people. At 4 percent, $1 million produces just $40,000 a year in income. If we could increase our withdrawals to 4.5 or even 5 percent each year, the extra income could go a long way. Here are five potential ways to do just that:

1. Work longer. The 4 percent rule assumes a 30-year retirement, from age 65 to 95. However, every year worked past 65 reduces the demand placed on retirement savings. In the Trinity Study, named after three professors at Trinity University who authored the influential paper, reducing retirement by just five years improved the chances that a retiree would not run out of money even at a 5 percent withdrawal rate. Further, working an extra five years gives more time for retirement savings to grow.

2. Die sooner. This isn’t as morbid as it sounds. As noted above, the 4 percent rule assumes a 30-year retirement ending at age 95. Living to age 95 is a conservative assumption. According to the Social Security life tables, very few people live to age 95. At age 65, life expectancy is 17 and 20 years for men and women, respectively. Thus, assuming a life expectancy of 95 for purposes of making retirement withdrawals may be overly cautious.

3. Ignore inflation. The 4 percent rule assumes that each annual withdrawal will be adjusted upward for inflation. The assumption is not unreasonable. It is intended to ensure that retirees do not lose purchasing power over time. As Ferri noted in our interview, however, retirees tend to spend less over time. In fact, the consumer expenditure survey by the Bureau of Labor Statistics shows that average annual expenditures drop sharply from age 65 to 75.

As a result, you might want to consider not adjusting withdrawals by the rate of inflation. The purchasing power of the withdrawals will go down, but spending needs are likely to go down, too. Of course, you could also try a middle of the road approach and adjust withdrawals for just a portion of annual inflation.

4. Be flexible. The 4 percent rule assumes no flexibility. According to the rule, retirees should withdrawal 4 percent regardless of market conditions or capital needs. However, it’s more likely that withdrawals over the course of retirement can and should vary. When the market is down, for example, it may be prudent to cut back as much as possible. Conversely, when the market is on a tear, it may be a good time to ratchet up withdrawals.

While such flexibility will be difficult for those just getting by, it can be a powerful retirement tool for those who can tolerate variable income.

5. Earn extra income. This last tip is my personal favorite. Rather than working full-time later in life, earning even a little extra income doing something you love can take significant pressure off of your retirement savings. Working part time has other benefits as well, such as helping retirees stay mentally and physically sharp.

The key is to recognize that the 4 percent rule is really more of a guideline. While it may be fine for planning purposes, it shouldn't be accepted at face value when it comes time to actually retire.

Rob Berger is an attorney and founder of the popular personal finance and investing blog, doughroller.net. He is also the editor of the Dough Roller Weekly Newsletter, a free newsletter covering all aspects of personal finance and investing, and the host of the weekly Dough Roller Podcast.