Another title for this blog post could be, why the 4% rule is unlikely to be right for you in retirement.
When you think about the withdrawals that you take out of your retirement savings over a lifetime in retirement, imagine that as a financial road trip.
You are going to drive for a long time, you hope it’s a long time, you hope it’s a great trip, but there will be a few bumps and scrapes along the way.
The speed you start at is your withdrawal rate (i.e. the amount you withdraw in the first year, divided by your savings).
The higher the withdrawal rate, the faster you’re going… and the more dangerous it is.
Now, if you had no brakes in your car, and one of the rules of the trip was that every year you had to speed up a bit (regardless of the driving conditions around you), what speed would you start the trip at?
I think your answer would be “slowly” – you have to speed up a bit each year to ensure that your retirement withdrawals keep up with inflation.
The next rule of the road trip is that you will have a car with average performance.
As you get faster, the average performance of your engine becomes noticeable – louder, maybe a bit smokier – and altogether a bit worrying, and you may wish you had chosen a better car at the start of the trip.
This is equivalent to have the average pension or investment, with average charges.
This is the retirement road trip for which the 2.7% rule would apply (when it’s only safe to withdraw 2.7% per year of your retirement savings in year one and increase it by inflation)
We think it would be crazy to set off on a road trip with no brakes, to only ever speed up and to just take the average car. If you add some brakes, allow yourself to slow down if driving conditions become a bit more dangerous and choose a better than average car, you can have a much better time.
For retirement withdrawals, that means that if you are able to vary your discretionary spending, have an annual review with your Financial Planner and choose pensions and investments that are better than average, you can start by withdrawing a lot more than 2.7% per year on day one.
If we take this metaphor one step further (I know I’m stretching a bit), before you start the road trip, somebody at the golf club will have told you that, in America, they drive a whole load faster than this.
This person at the golf club is the equivalent of the person who tells you to withdraw 4% per year of your retirement.
Feel free to tell him that they drive on the other side of the road in America, and they have different cars and driving conditions; starting at 4% could be the equivalent of driving a gas guzzler down the wrong side of the motorway!
With thanks to Jonathan Guyton and Michael Kitces for the inspiration for the metaphor!
For a Brit, withdrawing 4% a year from your pension pot in retirement is like driving a gas guzzler down the wrong side of the motorway Share on X