A podcast from the Mad Fientist about a Safe Withdrawal Rate got me thinking this week. Not so much about the maths behind it, or whether it is likely to work or not for me over the next thirty years, but thinking more about me over those thirty years instead.
You can’t take it with you, and as I head toward turning fifty four this year I increasingly wonder about how I will fare over the next thirty years? Because, in all probability, that’s about what I have left on this mortal coil.
We don’t do death very well in the Western world, so it’s quite difficult to focus on your own demise. Actually, I’ve read that it’s virtually impossible to imagine your own death in any meaningful way. Your mind can’t grasp it, and in a way the “4% rule” is a good example of this. If I read it right, and to make the maths simple, let’s say you have a million quid in a pension pot. If I withdraw £40k a year from that pot then, thirty years down the line, that million quid (allowing for inflation) will still be sitting there, pretty much untouched. It might even have grown. It might have dwindled slightly. Who knows for sure? But what I do know is that I doubt I’d have much need of a million quid at that age!
My feelings about this intensified at the end of the podcast where the interviewee, Michael Kitces, talks about “Lifestyle Creep” and lifestyle in general. He argues quite forcefully that you shouldn’t sweat the small stuff and, if you have your financial priorities right, then you’ve no need to worry about buying that Starbucks Mucho Latte or Big Mac (Large) for lunch, if that’s what you want. That sort of purchase just doesn’t matter in comparison to maxing out your mortgage with the first property you buy and then servicing the debt from your twenties onward. If you do that then you might not be able to afford a McDonalds for lunch in future.
Meanwhile, once you start living in a bigger house, buying a new car every three years, taking two or more holidays, hiring help for the gardening or cleaning and so on, it becomes very, very difficult to subsequently give those things up.
I can affirm the reality of this. Dispassionately I know I should downsize my property at some point for a multitude of good and financially advantageous reasons but, you know, I like the house I have, with spare rooms for guests or just to lounge around in. I like the garden, the spacious garage, the shed, the location and so on. Could I easily give them up? (Emphasis on the “easily”.)
The same could be said for cars. In my career, I’ve always had company cars that changed every two or three years. I’d really like to continue on with that, but does that really make sense? Financially, buying a new car every three years is jaw-droppingly dumb, but emotionally?
None of this internal debate matters if you’re loaded and are swimming in money through retirement, but it’s not hazarding a guess to think that most people will not be in that situation. If you ask me, it’s the middle classes that will be in for potentially the biggest shock. Talking to friends who work as pension advisors a 30k a year income is a desirable retirement income for many couples. This sits, however, very uneasily with the most popular middle class goal of retiring at 55. If I am calculating it correctly, and not allowing for any nifty tax manipulation, you’d need a £750k pot for that income on the 4% rule.
The Safe Withdrawal Rate is therefore quite a hard task master, especially if the point of it is to protect your capital and income generation. But surely you have to ask yourself, as you head into your dotage, how much do you need?
For me, looking at retirement, this is one of the biggest puzzles I have – how much am I going to need to service my definition of “a comfortable retirement”? When I had my year out, I was quite amazed by how little I spent on a week to week basis versus what I used to spend when I was working. I feel that would almost certainly continue as I head into my sixties and beyond. I’m just not going to need as much money in my sixties as I did in my fifties, and I think that same rule will apply even more to my seventies and eighties (if I get there!) As each year goes by, the chances are that my annual budget will be shrinking.
(There’s a potentially big caveat here when it comes to health, because who knows how much you want to spend on that as you grow older?)
Assuming I stay relatively healthy though, the 4% rule seems either to assume that you’re going to live forever or that one of your goals in life is actually a goal for death, through leaving an inheritance. I can see the sense in it for early retirement, but traditional retirement at 65? Not so much
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I like Pete Matthew’s (Meaningful Money) view that ideally you should die shortly after spending your last penny. I actually started my road to Financial Independence by selling a fancy car and putting the money into my pension. The new car every 3 years is a massive drain on your finances especially now that cars don’t rust. Much as I love cars I know that I don’t want to keep on working just to have a fancy car on the drive. I’ve heard that for a lot people their expenditure goes up immediately after retirement and then drops by 10% per decade. Probably all that buying Lamborghinis with the lump sum. Well you can’t take it with you 😉
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I see the 4% rule as only really appropriate to those who have unusually large savings especially since there seems to be a consensus that 4% might be too optimistic going forward. It is also aimed at Americans based on their historical returns – returns in the UK have been lower. Today a 2.5% rule might be more prudent! But at this level you would need truly enormous sums of money to provide a decent income. I suspect that is totally unrealistic for all but the highest earners (or exceptionally frugal).
That leads to questions over how you run down your savings and assets over your retirement. I struggle with this one. How long am I likely to live? How much do I even need to save? What should I have my money invested in to protect against inflation but stay safe? Which assets should I sell and when and in what order? How will my expenditures develop over time? Will the state pension still be there for me? My main asset is my house. Will I have to sell it? Do I need to sell it sooner rather than later? I doubt most people are going to relish the ordeal of having to sell their long time home in old age.
My father worked for a big blue chip company for his entire career and was able to retire at 55 with a generous inflation linked income (final salary pension). The most valuable aspect of that pension from my point of view was its simplicity and the peace of mind that went along with that. I will have to face a series of decisions in and leading up to retirement that will be little more than well informed (hopefully) gambles.
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I actually have a bit of a DB pension too, but I find it really hard to get decent information on it in terms of a projection. I have a rough idea because the company running it used to send out quite good projections and it does give me a bit of peace of mind. But, as you point out with your questions above, injecting uncertainty into the retirement years is much easier than finding answers to them.
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I agree with most of what you said here, but I think it’s a bit of a misconception that the 4% rule (and similar rules of thumb) is designed to leave your capital intact. While that may happen on average under the right assumptions, the rule actually aims to optimize the probability of ending up with a capital greater than zero at the end. I think most people would find it desirable to not hit zero money in their life-time. Of course, you may argue that a 99% or even 90% chance (see for example the tables in this latest RIT post: http://www.retirementinvestingtoday.com/2017/09/improving-safe-withdrawal-rate-for-uk.html) are too conservative.
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Yes, looks like I got it wrong, but that just shows you how confusing this stuff can be, and I’m interested in it!
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As I understand it, the SWR was determined on the basis of not running out of money by the end of a 30 year retirement, i.e. having a non-negative capital value left after thirty years, rather than still having your original pot left. If you want to leave money to heirs then you either need a bigger pot or a lower withdrawal rate.
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Thanks Scott, as per comment above, I got it wrong but I’m happy to be corrected. Back to the spreadsheets.
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To be fair, I think you have it about right. We are discussing the difference between statistically expected outcomes and worst-case outcomes. To my understanding, the 4% ‘rule’ is the *absolute minimum* safe withdrawal based on historic returns (from US stocks) over the past century or so. That means if you retired in 1929, mid-1960s, 2007, etc. (i.e. the worst of times) the 4% rule would nevertheless still hold.
For the vast majority of retirement years (I don’t know/too lazy to check the exact %, but let’s say it’s at least 50%) the expectation value of your pot would, indeed, be as you described: “If I withdraw £40k a year from that pot then, thirty years down the line, that million quid (allowing for inflation) will still be sitting there, pretty much untouched. It might even have grown. It might have dwindled slightly. Who knows for sure?”
As you are writing in generality, this ‘average’ outcome is correct. What the other commenters have picked up on is that if you retired in 1929, say (the outlier), then you finish the 30 years with $0. In retirement planning you obviously want to be aware of the freak analysis (especially as the freaky years seem to becoming more regular), but that doesn’t change the fact that the average result is what you said – a pot that is largely of the order of what you started with. Keep up the good work!
NB: Caveats of the mechanics of the 4% rule notwithstanding of course: no fees/US stocks/past performance not indicative of future returns etc. and so on.
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“I like Pete Matthew’s (Meaningful Money) view that ideally you should die shortly after spending your last penny. ”
Short of drinking a cocktail of barbiturates how is that in anyway practically achievable?
“If I read it right, and to make the maths simple, let’s say you have a million quid in a pension pot. If I withdraw £40k a year from that pot then, thirty years down the line, that million quid (allowing for inflation) will still be sitting there, pretty much untouched.”
As mentioned above, you have read it wrong. The 4% rule is about the probability of running out of capital before you die. Being able to live of the generated income without touching capital is a different idea.
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So I see, and choosing a £1m pot was probably a bad example too. Having a 40k income as a pension is a bit of a dream for the majority of people and most would hope to save from that.
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Cat793: that is my position nicely captured! I have an oversized divided portfolio owing to it being over several separate ISA accounts, plus pensions. How to ‘decumulate’ is an issue. Also, I think there is a risk of a intergenerational rebalancing which means a shift to taxing wealth over that for income or expenditure. So risky using pensions as an IHT avoidance measure. PS, don’t forget that most DB schemes have limited inflation protection. Mine is 5%. That could be crucial if you are looking at 30 years plus.
Incidentally, the UK interim life tables show that there is a 50% chance that at least my wife or myself off both will be alive on my 90 the birthday: 30 years hence.
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That point about intergenerational rebalancing is an interesting one. The limits to taxing earned income and expenditure must have just about have been reached. I agree that the focus will move to those living off income received from accumulated assets, especially BTL. It has started to happen already, Those who have benefited from quantitative easing and rising asset prices will be the target.
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The 4% rule also doesn’t include the drag of investment fees or taxes. Or apply if you’re not 100% invested in US stocks and bonds. Nor if you live beyond 30 years. There’s a few other things too but in short… the 4% rule isn’t a rule.
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Clearly you’re right, it’s not a rule, but as was quickly pointed out to me above, I both believed it and misinterpreted it at the same time. I’ve still got a lot to learn (and running out of time to learn it in!)
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Jim Collins’ recently discussed something called the Wasting Asset Retirement Model (WARM). Not sure I like the sound of it to be honest, but worth a read.
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Check out http://www.portfoliocharts.com with the UK option selected and your particular portfolio asset allocation. Opened my eyes to some options and likely up and down swings.
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In my own calculations, I’ve tried to work out how much I will need up to the age of 100. Unlikely I will get to this age but it’s as good a guess as any and guess it means I’m oversaving rather than under. However, I’ve worked on the premise that I will want to spend the same amount at age 80+ as I want to at age 60. Perhaps things will even out, ie at age 60, more will be spent on hobbies/social life and at age 80, more will be spent on medical/health stuff.
I won’t be following the 4% rule as I’m planning on spending most of my pot.
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Neither will I weenie! I have no family, so running down to ) will be an ambition.
I actually don’t worry about if I’m going to have enough, heck I don’t know what I’ll have. Currently by 60 I shoudl have more than 300k in the pension pot, I have about 350k in an account and whatever the end of the small company will bring. That might mean selling the physical assets and seeing whats left on the books or maybe selling the company, which would be better, ie more money and better from a tax perspective.
I do think sometimes you have to do the best that you can and allow that the future can’t be nailed down and not stress about it.
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