The Father of the 4% Rule Has New Ideas About Retirement Income 

If you’re reading Retirement Upside, you’ve probably heard of the 4% rule. 

In case you haven’t, it’s generally considered a safe income planning guideline that lets retirees withdraw 4% of their total savings in the first year of retirement and then adjust that dollar amount for inflation every year afterward to make their nest egg last for 30 years. The rule is ubiquitous in the mainstream media and among popular financial planning voices online, thanks to its straightforward answer to a daunting financial planning question: How much can clients spend in retirement without risking poverty in old age? But they may be surprised to learn that the rule’s creator, Bill Bengen, never intended it to be a baseline for retirement income planning. Quite the opposite, in fact.  

“It’s actually a rule that only applies for a very narrow segment of the population in practice,” Bengen recently told Retirement Upside. Ultra-risk-averse people living off a 401(k) account who want to make sure their retirement income plan would have worked out without adjustment during the worst period in the modern history of the stock market should follow it. Others who are accepting of more risk can afford to draw more income, especially if they’re willing to make adjustments along the way.

“I never intended it to be a panacea for ‘safe’ retirement income planning, but that’s kind of what it’s become,” Bengen said.  

Keeping Busy 

Anyone who has followed Bengen’s work in recent years will already know the 4% rule isn’t the end of the story, as the retired financial advisor and longtime retirement researcher has kept busy since leaving professional practice behind in 2013. Not only has he reassessed the “safe” inflation-adjusted spending rate, raising it to 4.5% in 2006 and to 4.7% in 2021, but he has also looked closely at the emerging category of risk-based guardrails and other income-planning frameworks. His latest analysis, for example, reviews what is known in academic circles as the Guyton-Klinger (G-K) Decision Rules withdrawal strategy. That sounds complicated, but its basic principle is to begin with a more aggressive income amount and then annually adjust retirement withdrawals up or down (or not at all) based on changes in the current withdrawal rate and portfolio performance. 

“It attempts to mitigate the risks of a pure cost-of-living adjustment scheme,” Bengen said. These include the potential for significant underspending early in retirement, as well as the risk of lower-than-necessary cumulative spending when portfolios overperform. “It’s potentially more appealing in practice because most Americans are comfortable taking some risk with their retirement income plan and making adjustments along the way.”

Running the Numbers 

Bengen has the benefit of being personal friends with Jonathan Guyton, one of the researchers for whom the flexible spending technique is named. “He helped me understand the intricacies of G-K,” Bengen said. “Despite his valued assistance, it took me almost two months to develop a process flow chart and prep my Excel spreadsheets to do the analysis. That’s why you haven’t heard from me in a while.” 

So what did Bengen’s latest work find? Put simply, retirees who are willing to follow the G-K method actually have an average maximum safe starting withdrawal rate of 9.6%, which is far higher than anything he’s encountered with a conventional cost-of-living adjustment strategy. There’s a catch, though. 

“G-K does a superb job of producing high initial withdrawal rates, which are amazingly consistent across all market environments,” Bengen said. Its shortcoming is that the cumulative real withdrawals, or the sum of the real value of all withdrawals made during the entire 35-year planning horizon, are generally lower. In fact, for all 361 retirement scenarios examined, save one, the conventional inflation-adjustment strategy generates superior cumulative real withdrawals, frequently by a large amount. This is an important fact for financial advisors to hear, he said, because the G-K approach is growing in popularity in the industry. 

“It’s useful for some in the population, including people who agree to the idea of higher income early,” Bengen said. “That could work for people, but you have to understand that the reduction in cumulative income could be 60% or 70% in extreme scenarios. That’s a risk to consider.” 

On to the Next Challenge 

What’s next on the docket for Bengen? He’s ready to take on Warren Buffett’s retirement income advice. 

Berkshire Hathaway’s 2013 shareholder letter says Buffett instructed the trustee for his wife’s bequest to put 10% in short-term government bonds and 90% in a low-cost S&P 500 index fund. During good times in the market, income can be drawn from the portfolio, but the cash reserves should fund spending needs during bear markets when stock prices have fallen. 

“That approach makes sense on first look, but you have to test every idea thoroughly when it comes to retirement income planning,” Bengen said. “Things that seem to make total sense need to be tested, and his proposal is quite a bit different from other schemes. I should be done with the analysis in about a month. It takes a while to set up my spreadsheets and procedures.”