Safe Withdrawal Rate Myths: Debunking 3 Common 4% Rule Mistakes
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- Опубліковано 1 чер 2024
- The 4% rule helps us understand how much we can safely take out of our portfolio each year without running out of money in retirement.
Yet, as simple as the 4 percent rule seems, the practical implications are drastically misunderstood. I explore the three common mistakes people make when applying this rule and how to avoid them.
Questions Answered:
How do RMDs impact the 4 percent rule?
Does the 4 percent rule account for changes in expenses and income sources?
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⏱Timestamps:⏱
0:00 - Questions from listeners
1:26 - Misconception 1 - RMD
3:27 - 4% rule applies to portfolio
5:51 - Assumption of 30 years retirement
7:51 - Misconception 2 - annuity distributions
10:01 - An example
12:33 - Misconception 3 - static cash flow
13:42 - Examples of changes
17:44 - Summary
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Nothing says you can't turn around and reinvest a chunk of an RMD in a taxable account. The RMDs just force us to realize taxable gains at a point in time.
Yeah that's what many do
correct
True, however, because taxable accounts may subject the retiree to taxable events such as capital gains and/or dividend and interest income reinvested amounts should be placed in tax-efficient investments such as Total Stock Market equity indexes (i.e., low rate of capital gains and high rate of qualified dividends) while rebalancing the portfolio across all retirement accounts. This may lead the retiree to rebalance their tax-deferred account to include a higher percentage of fixed income to balance out the tax-efficient equity portfolio in the taxable account. The positive aspect is the tax-deferred account should potentially grow at a lower rate due to the higher fixed-income holdings (i.e., Asset Location) slowing down the RMD amounts. Another reason to take more than 4% from the portfolio and reinvest it is after RMDs are taken there is still space available in lower tax brackets (e.g., 12% tax bracket). This may help with taxes in the future as RMD rates increase.
I think he covered this.. 4:55
And potentially move you into a higher tax rate at the same time, you don't want that if you can avoid it with proper planning
I hate annuities. Not only do they not keep up with inflation, but the insurance company gets a huge cut from the growth. Also if you pay post-tax money to purchase it, then all of the money you get from the annuity is taxed as ordinary income again.
Do you mean pretax money? PostTax money has already been taxed.
A smartly bought annuity can make sense for highly risk averse folks, at least as a component of total income streams. Perhaps as a foundation to cover base expenses. As long as they realize they’re giving up some returns in exchange for peace of mind.
As to inflation, they could split the difference by sizing the annuity larger than they initially need.
Keep in mind that spending typically falls dramatically as we age.
That sounds wrong - the annuity payment is made up of returning your principle with a modest amount of growth - you only pay tax on money you have not paid tax on IE... the growth - if the purchase funds, are post tax, have already been taxed on those funds - now, if you buy an annuity with a 401k or IRA NONE of the money has ever been taxed and in THAT case you would indeed pay tax on the entire distribution as you have paid no tax on ANY of the money.
Annuities can be viewed as filling the role of bonds in a diversified portfolio. It allows the balance to be in equities, which have historically beat inflation.
They are there to give you a life time income. Not beat the Market. Just one leg of the retirement stool. If you hate them, then dont buy one. Remember SS is an annuity.
Man, every time I watch one of your videos or really any other financial videos, I am so thankful that I'm due a COLA adjusted pension upon retirement. It definitely made me aware of the benefit of doing roth conversions while the tax brackets are relatively low as well. Hurts to pay the taxes now, but well worth it for the future, especially since the pension will give us such a high starting taxable base. Keep up the videos, and clarifications; there are a lot of ways to mess yourself up if you misunderstand the rules.
You do such a great job on these videos. They're clear, well organized, relevant... 👍
EXCELLENT! I think you went over every single scenario!!
Thanks, James, great content!
Thanks great video.
You do a great job explaining the details.
Thanks James, another very informative video!
Thanks for this. Very thoughtful.
Thank you for your clear explanation of the options.
Yes, agreed!
Excellent advice - thank you!
I do not take a fixed amount. I take what I need, no more and no less. I take only from the amount of income that the portfolio produces, up to 100% of the income produced, but only the income. This has been working well for the 8 years so far that I have been retired. I'm 70 so RMD has not started yet. I will continue to maintain this strategy until eventually RMD will force me to withdraw capital also, at which time I will redeploy as much of the RMD as I can to put that money back to work..
This explanation is easy to understand.
Thanks for the good info as always James. I much prefer this blue color background you're using btw :).
I realize this video is of a podcast, but the annuity example would be so much better with one if your graphs or tables.
James this is in my eyes is the best explaination video you have ever done. Your coverage of the 4% rule and the different variations depending on a person/ couples specific situation. I was aiming to retire this but I may now have terminal brain cancer. Everything changes with one person taking in the future versus two. I'm 64 and she's 64 this coming July. Thank so much for your insights.
Wishing you health
I am commenting before watching the whole video so pardon me if the comment is premature. Even if the RMD is over the 4 % (inflated per the year)that doesn't mean you cannot reinvest the balance that is not spent or that is greater than the targeted spending need? Correct?
Might want to watch the video prior to commenting next time.
The only issue is the RMD can put you into a higher tax bracket than the one you planned to be in. But if you have that much money in your 401K, I think you have already won retirement. :)
good point, but one made in early section of video #5:37 mark
New subscriber here, have found your content to be extremely helpful. Wondering if you might in the future consider putting out a deeper dive on early retirement? Maybe even a case study or example of a client who retired at around age 55 for example and all the major considerations? Thanks!
He's got a ton of them!
I just discovered him about a month or two ago....
He's by far, the best!
YES! 72t (SEPP) distributions
Excellent video
Great information, I’m 64 getting ready to retire. Thank you
Please do an episode on annuities. My understanding is most are scams and not worth owning/full of fees/commissions
You’re right, most are not worth it. You’re paying someone to manage your cash flow.
Really dumb comment. Annuities are great and very safe.
@@jaylynn7493lol wrong. Plus most people won’t do a good job managing their own money and cash flow.
Something significant that is missed here is that the payout from a single premium immediate annuity is NOT a yield but rather a distribution rate, which includes partial return of principle along with a small yield. A distribution rate is not a yield. Many, including professional investment advisors, miss this.
Great vid, thanx...
Q: What do you think of "Buffered ETFs?" (Also apparently called Defined or Targeted ETFs??)
My financial advisor recommended these as I get closer to retirement, I am thinking kind of like a step between a full investment and Bonds...
I'd never heard of Buffered ETFs before...
It sounds lower risk, which is good, but having the cap on the top makes me worry if it is worth it...
Or does it make sense to have some in a portfolio???
I think the 4 % rule is great to determine retirement readiness. If I need $50,000 in retirement expenses then I should have 25x that amount to retire comfortably. If I pass that test then I spend what I need. If my mortgage is paid and my expenses are fixed, I don’t increase my spending by some published inflation rate. If I spend a bit more for a trip, I don’t worry. My portfolio has returned well in excess of 4% even if I keep a few years in cash given the recent interest rates. RMDs are a tax issue not a spending guideline.
$50,000 today is not going to be the same as $50,000 in 25 years, although Social Security should adjust to account for some of that.
James, I would be curious to know what retirement planning software you use.
Hi James, does one have to be working at a firm in a FA or similar fiduciary capacity to become a CFP or can one obtain it on their own? Would that be feasible or does one need a firm's sponsorship?
Just because you with draw that amount from your Ira doesn’t mean you have to spend it!!! Just invest it
Just started viewing your videos. The 4% guide, is supposed to be indexed to inflation, and last for 30 years, for a 92% likelihood that the balance will more than zero at Year 30. At 10 years, at 3% inflation, the 4% becomes 1.34 x 4% = 5.4% at year 10. James explained it. Vanguard studied it and discovered that the withdrawal rate would need to be around 3.5% to achieve the same 92% success likelihood in this Century. This is because the historical period now includes 2008 in which the S&P dropped 39% during the January 01 and December 31 period, introducing a mathematical plunge. Another interesting factoid, based on Fisher Investments, is that a 80/20 equity/bond portfolio isn’t that much better than 50/50.
The funny thing is that I just watched an interview with the creator of the 4% rule and he says that 5-5.5% should be the new rule. He also hates to call it a rule.
Great video. Great to point out the annuity inflation flaw! As for the RMD's I think too many people worry too much about RMD's. While it's smart to avoid any taxes you legally can. To me if I end up with huge RMD's and a massive tax bracket as a result, that's a huge success, It means my portfolio has grown well, I absolutely won't run out of money. I'll have plenty to spend or give away. Am I wrong?
I’m the guy in the boat you’re talking about. I retired early because of my mother’s health issues and started taking distributions to replace my salary. Now at 64, I finally got around to looking at the RMD and was shocked when I found out how large of a distribution I will be forced to take at 72. (About twice what I’m pulling out now). I was upset about the taxes and then thought, “It’s actually a good thing to have such a problem.”😉
You aren't wrong, but with a little planning, why not maximize returns and minimize taxes by using Roth conversions to reduce required RMDs? Rather than throwing money away or donating to the U.S. Government, I prefer to leave any unused money to family.
@@Kimmeryou are not donating money to the Government. The RMD was installed to stop excessive money, that was tax deferred, to be tax avoided completely when you die because your heirs will get the tax deferred money, on a step up basis and avoid tax on salary income.
This idea of the RMD approximating the 4% rule is something I’ve used to evaluate whether to do Roth conversions.
What you quickly realize is what you expect your tax rates to be now vs in the future can make a big difference.
RMDs are a great reason to have Roth IRA funds in addition to a Trad IRA and Trad 401k
Very helpful❤
GOOD video this is a super important topic.
Re annuities - LOL - go see what the cost for an inflation adjusted annuity costs:-) max I could find is a 3% inflation adjustment and they are DARNED expensive - what happens when inflation hits 5-6-7%:-) you are way better off in the market unless you are totally risk averse and have a TON of money to start with, chances are you didnt GET that ton of money (assuming you earned/invested it) by being totally risk adverse - unless it was handed to you.
After running my situation under a dozen different softwares, and speaking in depth with my UBS wealth manager, the BEST option for longevity of retirement funds is FLEXIBLE SPENDING - otherwise known as NEEDS BASED spending, if you use a linear withdraw model it really hamstrings your calculations and for most it isnt reality.
Check out the Hebeler Autopilot II
My favorite....
And yes, You Must be flexible or you're going to need to downsize, work part time or do something creative...
I bought an annuity last year. It was a small amount compared to my portfolio. It's purpose was to smooth out the impact (emotionally) that a large market correction would have on my behavior in investing. The same goes with paying off my mortgage early. The only way to get the better returns from the market is to stay invested in the market during turbulent times. If that means you take some of that money off the table, then so be it.
The thing that scares folks is, what if you retire and within a year or two the market runs into a 2008 situation, where the market lost 40% in a year? I know folks who retired into that. They did ok survival wise. But their retirement dreams went up in smoke. As a younger person (at the time) I shrugged it off, knowing it would come back, and it did. But someone newly retired doesn't necessarily have eight or ten years to wait. Every year is precious. By the time 2008 righted itself, many who had retired just prior to that saw the years when they were still young enough to enjoy the money frittered away. The money came back in time for their children to inherit it. That's why guaranteed income is so attractive to many.
Technically it's not "your mortgage", it's the banks. The bank holds the mortgage you hold the obligation to pay the note. Try not to enter retirement with a mortgage.
If you can pay for it with your distribution, why not? It’s like any other expense you’ll have in retirement. My concern is the big push for people to pay off a mortgage (maybe at below 2%) early when a better option would be to invest extra cash in the S&P 500 (8%+ historically and 20% last year).
Annuities aren’t one size fits all. Not appropriate for everyone and especially for all your retirement. However, there ARE annuities that are invested and do continue to grow, keeping up with inflation WITH guaranteed income! Plus death benefits which are great for people who are uninsurable. You have to know what annuity works best for you. They get a bad rep, but I’ve seen many retirees thankful they incorporated it into their plan.
what type of account should you have money in if you plan to pass some money onto kids. IRA and Roth IRA are then consider inherited IRA and then those account have to be closed in 10 years after inheriting them
Does a backdoor Roth IRA conversion count towards the RMD?
No, unfortunately. Having less in your tax deferred account does mean that your RMD will be smaller, but the conversion amount does not count towards the RMD.
The RMD table is actually another way to take withdrawals from your accounts, and it has a time horizon into your 100’s. It is actually MORE conservative than the 4% rule, since it doesn’t start till 73 or 75.
But, the point mentioned that spending tends to decrease over the years is very much true. Only in rare cases will the very old have higher late life costs.
Except when they end up in a nursing home. Then expenses can go through the roof! It's not unusual for nursing home care to cost over $100,000.00 a year. That can mess with your 4% rule real fast.
If RMDs force you into an overall withdrawal rate that exceeds 4%, might that not be an indication that withdrawals were probably too low before you reached the age where RMDs were required?
This is why my wife and I hired Root Financial to help us.
Depends.
I would say the biggest 4% rule mistake is that its a hard rule and not just a soft rule that can be adjusted depending on conditions. Say the market is down so you cut expenses to draw out less. Or the market has been doing extremely well like in the matter of three years the market doubled and inflation is historically extremely low then you could spend a lot more money.
In the long run though, doesn't that all average out, and that's exactly what the 4% rule is all about? Averaging out? If you go hog wild in good yeild years, those good years cannot average out the bad.
In your annuity discussion your didn't mention one other key reason to avoid them. Under the 4% the majority of scenarios don't draw down to zero. So you are loosing a huge amount of your final portfolio value in all but the worst case scenarios.
I just did my taxes with a large distribution [to me] from my IRA but I was not taxed on it due to low income. I do not have an RMD for 6 years. Can I just take out the max. [between 15K and 20K] from my 3 different IRA's to the point of taxation for the next 6 years till the RMD's kick in?
After 59.5, you can take out whatever you want from your IRA. The RMDs are just to keep older wealthy people from trying to just leave it to their heirs.
Taking out just enough to stay in one of the lower tiers of taxable income is a good idea, BUT it might still be better to leave in tax-protected. I would get a low-cost financial advisor to run the numbers for you, especially since you could be affecting the portion of your SS that is taxable.
Seek out a tax professional because you may be able to do Roth Conversions for the next 6 years and save yourself thousands in taxes.
You might want to consider doing those distributions in the form of Roth conversions.
If you can take money out of your pre-tax retirement accounts now tax-free because of your tax bracket, think about converting at least up to that level to Roth IRAs. There are no RMDs on those and no matter how much they've grown, when you eventually do take distributions from them they will be tax-free regardless of what your tax bracket is. Better yet, if you can use software to do a projection and find that your tax bracket or taxation of your Social Security might put you in a 12% or higher effective federal tax rate, it could be worthwhile to take pretax retirement money out to put you into the 10% bracket and convert it to Roth money also. It depends on your tax bracket now vs later.
I have to take RMD this year, the formula 26.5 years use to calculate my IRA withdraw each year. Do I have no others choice to withdraw my IRA ?.
Yes it's required. Note the "required" part of the term "Required Minimum Distribution".
Just remember the RMD is not a total number. It needs to be calculated for each retirement account (with the exception of Roth accounts)
Well I took RMD "s before I was 70 and remember you are going to pay more in taxes and if you don't need the money and have paid off all debts then get municipal bonds because they are not taxed !!!!
You don’t have to spend it, reinvest!
The 4% rule is based on what has survived historically over any 30 year period. If you are waiting to take distributions when you hit the RMDs, is 30 the year period really applicable? Currently, RMDs kick in when you turn 72, but that is changing as for many of us it will be kicking in when we turn 75. What are the odds that we are all living to 102/105?
The 4% rule has nothing to do with RMDs.
That doesn’t invalidate the question asked either!
James Annuities can ADD an inflation adjusted income how come you don’t mention this?
Only Government Employees receive pensions that are CPI indexed inflation. SS is indexed, and yet people complained that the CPI index is not enough. My private pension has been frozen since I left them at age 30. The $X benefit is still the same 35 years later, and isn’t CPI indexed. The average Government employee makes more money and receives better benefits than the average taxpayer, especially the uniform workers like Police and Fire. In San Jose, a fireman received $300,000 in unused vacation days, which in ANY private company, it would be limited to 4-8 weeks or 2 months of salary.
Assumes person has no other investments in taxable accounts. Those with significant RMDs likely have other investments as well. About 50% of my retirement savings. Part of that 50% is in Roth IRAs (no RMDs). The rest are in taxable accounts. RMDs are meant to draw down the savings over time. And by age 85, even at a 7% withdrawal rate, what is your life expectancy? And spending tends to taper off as you age. I hate annuities! No liquidity and no growth.
Love this video!!
I don't get it.. Why are people worried about taking more than %4 after the age of 72? Are they planning on living to 120 years old?? Just reinvest the money into a taxable account. Sheesh
The 4% rule uses 4% of the starting amount, adjusted for inflation. RMD percentages are a percent of the remaining balance. This is HUGE difference than James didn't make clear.
What they're worried about is a huge tax bill that can occur with RMDs if you have significant savings. That's why Roth conversions can be an important part of planning.
It’s all about what you have in traditional 401k and what your incomes going to look like when RMD’s kick in. If you are getting a pension and social security and have 5 million, your RMD could push you into the 30 percent bracket.
Why do we tell people for 30 years leading up to retirement that they can expect to get a greater than 4% return (typically more like 7%) and then tell them in retirement that they can’t even expect to make 4% which would cause their savings to last in perpetuity as you say it can only last 30 years?
Because the market is volitile. Look up sequence of return. Basically while the market does give ~7% on average it's not 7% every year, some year it's 10% and some -10%. If it's a down year right when you retire it'll have more of an impact then if it's a down year near your death. If it was a straight 7% every year you could take out 7%, but it's not.
I'm 35 and investing 24% of my gross income and currently have 1.6 times my income saved in various retirement accounts. My question is, should I even try to factor social security into my retirement picture?
First - kudos to you!! the 24% is great -- according to the MoneyGuy youtubers you are a financial mutant - a prodigious accumulator -- but the Fidelity age/factor tracking rule of thumb would rather your retirement account be " 3x (times) your salary" at 35. of course a good financial calculator could give you your own personal plan.
OK - enough blowing smoke --- now, what if you do get a substantial income from social security and you do not plan on roth conversions or some way to reduce your RMD impact of IRA accounts, the amount would put you into a higher tax bracket very early in your RMD journey ... so I believe that the scenario you describe is worth doing a financial calculation what-if to see if SS impact on taxes can be reduced ...
No
Social Security is known as the ‘third rail of politics’ for a reason! (Homage to your user name😉). Any politician who even thinks of reducing SS benefits will be gone next election. IMHO, it will be there when you retire, so I would add it in. You’re doing great regarding the percentage you’re contributing and so should be in good shape come retirement.
@@glasshalffull2930 Exactly. Any politician that wants to keep his job will find the money to keep paying Social Security. Forget the fear mongers.
Realistically, though, I would not count social security into your plan. By the time you retire, there’s no telling what will have been done to it. Will early retirement still be age 62, or will it be 65? 67? I’m 62 now, and I just always considered SS extra money. It was never a part of my plan, so it’s a gift. Better to be prepared…
A MYGA probably won't pay you 6% for the whole 30 years
A SPIA would be more likely to do this
James seemed to be confusing the two.
I would like James to question the inflation rate assumption which underpins his constant argument against annuities as well as supporting the need to have large portfolios to provide inflation protection. The retired (especially the 79% of home owners) have reduced exposure to the cpi sectors of younger cohorts, resulting in only 75% of inflation impacts. Furthermore, the expenses of the spending smile show a general reduction of 1-2% per year from 65-95.
Inflation does not require a constantly increasing expenditure above a base portfolio withdrawal as per the 4% rule --- this has been in the financial literature for decades as well as being supported by the studies using the survey of consumer finances. However, this incorrect assumption still seems to be part of your planning with your clients. I am not sure you are addressing this, even with your normally very data-driven phrasing of retirement scenarios.
Correct, James didn't address this. It is known that people spend less as they age. Not all sources of retirement income need to increase with inflation. However, the big unknown is increasing health care costs, which nobody can predict. This can result in a "smile" shaped spending curve, but nobody knows what sort of higher health care costs they might encounter so it's difficult to plan for that.
Most folks just want to keep that money making income tax deferred. They can always push the remaining post tax cash right back into the same investment inside their brokerage account.
The annuities are indexed!!! To the market so why is this different?
Not all annuities are indexed. It depends on the terms of the annuity you decide to buy.
Neither a MYGA or a SPIA is "indexed". Years ago you could get a SPIA indexed to inflation but they didn't sell so the insurance companies dropped them.
Whoever asked the question doesn’t even understand that no one is forcing you to spend the RMD lol.
Why would you even think the RMD applies to your brokerage account?
I don’t
Hi James great info. I went to your site as a prospective client. I am curious about your fee structure. Is the 1% on the first $1,000,000 an annual fee, a one-time fee, or something in between? Thanks!
🤘
Annuities were the biggest scam ever.
Yes, thats not how lifets more like 15 to 20. Stop planning to live to be 100.