A Simple Formula for Calculating “Safe” Retirement Spending
by AAII Staff | April 05, 2019
For nearly two decades, the 4% rule has served as a benchmark of how much retirees can safely afford to withdraw from their nest eggs initially, with annual increases for inflation, and be reasonably certain they would not outlive their savings over a 30-year retirement.
In the aftermath of the financial crisis of 2007 to 2009 and in the face of record-low interest rates, new research has called into question this long-standing retirement spending rule of thumb. William P. Bengen, retired financial planning practitioner, published his initial research on the 4% withdrawal rule in the Journal of Financial Planning in 1994, and based it on a $1 million portfolio split 50/50 between large-cap stocks and bonds. In 2004, Bengen updated his research, adding small-cap stocks to the model and raising the withdrawal rate to 4.5%.
In 2016, the Society of Actuaries’ (SOA) Committee on Post-Retirement Needs and Risks awarded first prize to Evan Inglis, a senior vice president for Nuveen Asset Management, in a call for essays for his discussion about a simple strategy to determine how much can be safely spent in retirement.
Inglis calls his method the “feel free” spending level. The formula is simply a person’s age divided by 20. The resulting number is the percentage of savings a person can spend over and above any Social Security, pension or annuity-type income.
For example, a person who is age 70 can safely spend 3.5% of their savings (70 ÷ 20 = 3.5). A 60-year-old would be limited to 3% (60 ÷ 20 = 3.0), while an 80-year-old can spend 4% (80 ÷ 20 = 4.0).
The term “feel free” refers to the fact that a person spending at this level should have little worry about depleting their savings. Inglis believes this rule will not only provide enough money but will also allow a retiree’s portfolio to grow should historical returns be repeated. If returns are lower in the future, then the level of spending should still be enough to last a lifetime.
A modified version of the formula calculates the upper limit of what can be spent. Dividing one’s age by 10 gives the “no more” level of spending. Spending close to this level (e.g., 7% for someone who is age 70, or 70 ÷ 10) will cause savings to “almost certainly drop significantly over the years, especially after inflation is considered.” Inglis adds that “one should not plan to spend at that level,” with the exception of a special circumstance such as a large medical expense.
He added that common sense needs to be applied based on individual circumstances. Having a long-term care insurance policy can allow for a slightly higher spending rate. The potential loss of annuity income, such as a spouse’s pension or Social Security, will alter spending. If interest rates rise significantly, sticking with the divide-by-20 rule would make sense. An expected increase in future income (payments from a deferred annuity) or reduction in spending (e.g., paying off a mortgage) will require adjustments to future spending rates.
Source: “The ‘Feel Free’ Retirement Spending Strategy,” R. Evan Inglis, Society of Actuaries Diverse Risk: 2016 Call for Essays, April 2016.
Discussion
Richard Shaw from AZ posted over 7 years ago:
I have commented on similar articles about safe spending levels in retirement. There needs to be an additional statement about RMDs from IRA/401k plans although RMDs are a function of ages and portfolio returns. For example at age 71 the RMD formula will require a percentage of 3.773% at age 71 for myself and 76 for my wife. Assuming a 4% portfolio return the RMD increases each year so at 75 it becomes 4.37% and so on each year. The point is the age/20 formula may be overridden higher by RMD percentages. The formula gives at 71 3.55% and at 75 3.75%.
joe ragg from OH posted over 7 years ago:
All these make sense mathematically. But my spin on life is I want more in my late sixty and early seventy’s when I can still enjoy it. Hence, I plan on taking more now and plan on taking less as age takes its toll. I would like to see a plan that starts at maybe 7 per cent and is then reduced slowly as you age
Richard Shaw from AZ posted over 7 years ago:
I should clarify my previous comment. The 4% return does not affect the % of the RMD but is does affect the $ amount of the RMD based on the prior year ending account balance and also ultimately the life of the account.
Mij Airaf from MA posted over 7 years ago:
The RMD requirements don't require you to spend the money. You only have to withdraw the amount from pretax accounts.Just pay taxes on that amount and reinvest the balance in an after tax account.
Wayne from TX posted over 7 years ago:
To make it really simple, always spend less than all your after tax income and reinvest any unneeded funds.
John Lambert from NJ posted over 7 years ago:
Comparing this "feel free" rule to Bill Bengen's detailed and insightful work is ridiculous. At 65 this "Feel Free" rule results in a withdraw rate of 3.25%. Real safe. Too safe, as most can't save enough to afford to retire. $1,000,000 in savings will only result in $32,500 in income. Bill Bengen used historical financial returns to determine the highest withdraw percentage that would still preserve a portfolio during retirement. For a diversified portfolio with 65% in equity this is about 4.5%. This rate included an annual inflation adjustment for clients who wanted to maintain their lifestyle in retirement. I would encourage anyone nearing retirement who wants to understand the trade-offs involved in determining their "safe" withdraw rate to purchase and read Bill Bengen's "Conserving Client Portfolios During Retirement"
Steve from GA posted over 7 years ago:
Comments on the "safe level" 1. If other streams of income such as SS, pensions, etc take care of the "must" expenses the IRA withdrawals are simply "playcheck" and can be withdrawn at will unless one wants to leave a bunch to the kids. I suspect this is true for many AAIIr's 2. If one puts a 2% for a personal inflation rate on the withdrawal into a Monte Carlo simulator the chances of running out go to miniscule . Recent research has shown that if the retiree is making over about $100,000 they will actually experience dis inflation over a 30 year retirement 3. James Cloonan logically advocates an 80 % stock allocation even in retirement; that would also blow the 4% rule out of the water 4. One of the best AAII articles I have seen on the "Sequence of Returns" states that just rebalancing once a year would totally eliminate the chance of running out of money 5. Rental property, with mortgages dropping off , loans paying down, and rents increasing allows much higher withdrawal rates 6. While Monte Carlo shows it is theoretically possible to run out in 30 years, if actual stock market returns are used in order no one would have ever run out with these low withdrawal rates in the history of market returns 7. Let me phrase it this way; IF you allocate only about 50 % to stocks, and if you need the withdrawal every year for must expenses; and IF these expenses inflate 3 % every year for 30 years (yor mortgage won't for example), and if you live to be 95..you could be on Medicaid for the last few years..BUT, going from say a 4.5% withdrawal to 100% (run out of money) , one has at least a DECADE to "see it coming." Just monitor your withdrawals and you will be OK 8. in my opinion, the 4% withdrawal rule has confused a lot of retirees into thinking that they must live off the dividends; don't ever touch the principal; I have friends with millions who will not touch it. One day they will wake up to see they are going to have 5 - 10 times what they started with after 30 years. There, I said it!!
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