My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Wednesday, February 5, 2014

How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 2

On Monday I introduced the 4% rule, the most commonly accepted rule of thumb retirement strategy. Today I discuss the guideline and its development in greater detail. As noted in part 1, Moshe Milevsky and other retirement experts feel the rule is misleading and a terrible rule. I hope by the time you finish reading this series you will have your own opinion on the 4% rule; whether that opinion is similar to Mr. Milevsky’s or whether you feel the rule has practical application for you, as a starting point for your
retirement calculations.

Conventional Wisdom – The 4% Withdrawal Rate

The 4% rule is a planning guideline for a sustainable rate of spending over a 30 year retirement. Years ago a brilliant financial planner by the name of William P. Bengen (an MIT graduate in Aeronautical Engineering) got tired of being asked how much money his clients needed to retire, so he initiated a study that basically concluded that if you retire with a diversified portfolio split 50/50 between bonds and stocks, you will be able to safely withdraw 4% of the initial balance, plus an inflation adjusted amount for the next 33 years and quite possibly as long as 50 years.

For example, if you have $800,000 when you retire, under the 4% withdrawal rate you can take out $32,000 the first year. If inflation is 2%, your second year withdrawal amount will be $32,640 ($32,000 + 2% x $32,000). If inflation is 1.5% in your third year, your withdrawal will be $33,130 ($32,640 x1.015%) and so on. It is important to note, this is not a percentage of portfolio withdrawal method where you take the ending balance at the end of each year and draw 4%; but is a consistent withdrawal amount based on your original nest egg adjusted for inflation each year, which some experts find distasteful.

If you wish to read Mr. Bengen’s initial paper, here is a link to his October, 1994 paper in the Journal of Financial Planning. It should be noted that in a subsequent study, Mr. Bengen added U.S. small-company stocks to the mix, which increased the portfolio's volatility and potential return. To adjust for this, he revised the withdrawal rule to 4.5%. However, I will continue to use the more conservative 4% withdrawal amount for discussion purposes.

So what does Bengen say today, with our historically low interest rates? In this MarketWatch article by Glenn Ruffenach, the author says “Bengen has never claimed that his findings are right for every retiree. Indeed, he thinks some of the latest research about market valuations is terrific."
Ruffenach goes on to say “He told me recently that he  started with a specific set of assumptions: a retirement lasting 30 years, with savings in a tax-deferred account and nothing left for heirs. Change just one of those parameters, he says, and your "safe" withdrawal rate may differ. Still, Bengen notes, 4% remains a prudent jumping-off point for calculating withdrawal rates from nest eggs. Just keep your plan open to some adjustments.”

In this 2012 paper written by Mr. Bengen, he discusses some contingency planning, which includes potentially reducing spending and increasing income.

Mr. Bengen did not provide a detailed summary of the market returns he used in his calculations, although he provided some returns for certain extrapolated years (10.3% for stocks, 5.2% for bonds and 3% inflation ). However, in this article by Joanna Pratt, she suggests that the 4% spending assumptions are based on a 9.2% stock return, 6.85% bond return and an inflation rate of 3%.

The Trinity Study – Support for the 4% Withdrawal Rate

A subsequent study, known as the Trinity Study by Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz supports Bergen’s assertions. Some critics say this study supports Bengen because they use the same flawed data. Their 1998 paper can be found here

The Cooley, Hubbard and Walz study produced a number of conclusions, including:
  • Early retirees who anticipate long payout periods should plan on lower withdrawal rates.
  • Bonds in the portfolio increase the success rate for low to mid-level withdrawal rates, but most retirees would benefit from allocating at least 50% to common stocks.
  • For stock-denominated portfolios, withdrawal rates of 3 to 4 percent represent exceedingly conservative behaviour and will likely leave large estates.
The authors comment that if history is any guide for the future, then withdrawal rates of 3-4% are extremely unlikely to exhaust any portfolio of bonds and stock (in almost any combination).

But what happens to your retirement planning if stock market history does not repeat itself? Poor stock market returns for the last few years (until last year), countries defaulting or close to defaulting, historically low interest rates and tough economic times have caused some pundits to say we are in different times and the 4% rule is outdated, as it only captures periods of great prosperity. In part three of this series, which I will post next Monday, I discuss Moshe Milevsky’s unique retirement calculations and then the various modern studies and reports on what is the proper withdrawal rate upon retirement.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.


  1. Good article Mark.

    I don't like the SWR of 4%. I don't like thinking about any withdraw rate because my intention, although this certainly hasn't happened yet and I'm 20 years away to see if it works, is to live off the interest and dividends paid to me by my capital.

    If and when I need assisted living or something in my old age, then I will use the capital.

    Using a very conservative estimate, I hope a $1M portfolio will yield 3% per year. That's $30K per year, tax-efficient income and I don't have to touch the capital at all.

    As inflation rises, say, 3%, I hope that is provided by either capital gains or indirectly through dividend increases. If I can't get 3% real return over many years of investing in stocks, say >5, 10 years, I suspect we're all doomed.

    If I was a retiree heavily into bonds, I'd be sweating now. I totally agree with you early retirees or in fact all retirees should have a good 50% if not more invested in equities and common stocks. If you can hang with the short-term volatility, I would almost go as far to say nothing wrong with a diversified portfolio of 100% stocks and one or two years' worth of cash for short-term living expenses.

    I look forward to part 3 and glad I made it today to read about it (as per my comment in part 1).


    1. Hey Mark, glad you made it too, I want to be able to rub it in your face when the Leafs win the cup sometime in the next 30 years:)

      I know lots of people dont like the 4% SWR, today was a historical set up for the rest of the series. Your plan looks good, but most people will need to draw down their principal, so they need to consider a withdrawal rate or other alternative. Thx as always for your comments.

  2. I find all these simplistic articles on the web about the 4% rule and retirement to be missing one big point for the Canadian retirement. The biggest investment we will have to fund retirement is RRSPs. I have seen very few models that give a detailed picture of how to manage the draw down of your RRSP and take into account the minimum RRIF withdrawals. Perhaps because it is too complicated for a general article and that is fine. But for my RRSP the 4% rule is not the consideration. It is balancing the withdrawals between my wife and I so that when we turn 71 our income does not spike. We are lucky enough to be in a position to also build a non RRSP account including our TFSA and we will apply a withdrawal rate to that account. Are you going to be brave enough to tackle things from that angle? As a tax expert you should be well equipped. Good luck!

    1. Hi Anon:

      Sort of a fair comment. This series is not intended to provide such detailed advice. Typically, my clients financial planers or investment advisors will set out such a plan and I provide a tax overview of the plan or where they have no planner, I will work with them, but it is very fact specific. I note your issue later in the series, but "I am not brave enough" to tackle it within this series. I actually have a blog I started on the exact topic you note in my blog inventory, however, it has stalled, because in the end, I think the topic is too fact specific and any attempt to deal with it will again result in a simplistic discussion. So in summation, I don't think you will ever get an article or blog that does the topic the justice it needs and you need to co-ordinate your planner and/or accountant (if you have these advisors) to provide a plan based on your personal situation.