Latest / TaylorMade Retirement with Taylor Demars, CFP® / Everyone Is Wrong About the 4% Rule

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Everyone Is Wrong About the 4% Rule · TaylorMade Retirement with Taylor Demars, CFP®

0:00
SPEAKER_00: Today's content is pulled from Taylor's YouTube channel.
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SPEAKER_00: If you want to watch the video version or catch more great content, subscribe by clicking the link in today's show description.
0:13
SPEAKER_00: Welcome to Taylor Made Retirement, where we explore what it takes to build a retirement that works for your money and your life.
0:20
SPEAKER_00: With third generation certified financial planner Taylor DeMars.
0:28
SPEAKER_01: Somebody taught you a rule.
0:30
SPEAKER_01: Maybe it was a financial advisor, a YouTube video, or an article you were reading at 11 p.m.
0:35
SPEAKER_01: trying to figure out if you could actually retire.
0:37
SPEAKER_01: It's 4%.
0:38
SPEAKER_01: Withdraw 4% of your portfolio each year, adjust for inflation, saying you won't run out of money.
0:44
SPEAKER_01: And it sounds safe, but it's been repeated so many times that most people are now treating it like a law of physics.
0:49
SPEAKER_01: But you have to ask, who told you that?
0:51
SPEAKER_01: And more importantly, who benefits when you believe it?
0:54
SPEAKER_01: Because after working with hundreds of clients with substantial savings for retirement, I can tell you that the 4% rule isn't just outdated.
1:00
SPEAKER_01: For someone at your savings level, it's actively working against you.
1:03
SPEAKER_01: It's not because it'll cause you to run out of money, but I see firsthand how it causes smart, disciplined people with more than enough save for retirement, ending up dying with millions that they never touch.
1:13
SPEAKER_01: My name is Taylor Domars, I'm a third generation retirement planner and tax strategist.
1:17
SPEAKER_01: And today I'm going to show you exactly where this rule breaks, who benefits from you following it, and what you should be asking instead.
1:23
SPEAKER_01: And to be clear, this isn't a shot at Bill Bengen's original research.
1:27
SPEAKER_01: The problem is what the industry did with it afterward.
1:29
SPEAKER_01: Okay, so where did this rule actually come from?
1:31
SPEAKER_01: Bengen's 1994 study asked a very narrow question, asking if a retiree had a portfolio of stocks and bonds, nothing else, no other income at all, and they took out a set percentage in year one, then raised that dollar amount every single year with inflation, what's the highest starting rate that they could have survived in the worst 30-year market stretch in history?
1:52
SPEAKER_01: His answer, about 4%, which is useful for that specific scenario.
1:56
SPEAKER_01: The problem is that scenario describes almost no one I've personally sat across from.
2:00
SPEAKER_01: Think about planning a road trip this weekend with a paper map written back in 1994.
2:05
SPEAKER_01: It may have been an excellent tool and map back in 1994, but it has no idea that a new interstate was built.
2:10
SPEAKER_01: It has no idea what roads right now are torn up.
2:13
SPEAKER_01: And it definitely has no idea where you're starting from, where you're trying to go, or what you may want to do or see along the way.
2:18
SPEAKER_01: It doesn't mean that the map is wrong.
2:20
SPEAKER_01: It just is incomplete for the trip that you're actually taking.
2:23
SPEAKER_01: That's what the 4% rule embodies.
2:25
SPEAKER_01: The industry took something useful for one specific trip and started handing the same map to everybody.
2:30
SPEAKER_01: But the problem is it's blind in three specific places.
2:33
SPEAKER_01: First, to the income in your portfolio.
2:35
SPEAKER_01: Second, the taxes inside your portfolio.
2:38
SPEAKER_01: And third, the spending that your portfolio is actually there to fund.
2:41
SPEAKER_01: I'm going to show you all three because each one is worth real money to your plan.
2:44
SPEAKER_01: So let's start with income.
2:45
SPEAKER_01: The rule doesn't know about things as basic as your own Social Security or your spouse's.
2:49
SPEAKER_01: It doesn't know whether you have a pension, rental income, or maybe you want to be consulting part-time into retirement because you actually enjoy the work.
2:56
SPEAKER_01: It measures one thing withdrawals from your portfolio, completely alone, funding an entire retirement, which isn't necessarily yours.
3:03
SPEAKER_01: So let's take a married couple, both 65 years old, retiring this year with two and a half million saved.
3:08
SPEAKER_01: They want to spend$120,000 a year to live the ideal retirement they've been picturing.
3:12
SPEAKER_01: But let's loop in their two Social Security checks.
3:15
SPEAKER_01: For many professionals I work with, that's about$60,000 to$70,000 a year combined.
3:19
SPEAKER_01: And if they want to spend the$120,000, the portfolio may need to only supply about$50,000.
3:25
SPEAKER_01: On$2.5 million, that's roughly a 2% withdrawal rate.
3:29
SPEAKER_01: Not 4%, but half of that.
3:30
SPEAKER_01: But 2% isn't the answer either.
3:33
SPEAKER_01: It proves the portfolio isn't funding retirement alone.
3:36
SPEAKER_01: And that starting with a fixed percentage gets this planning backwards.
3:40
SPEAKER_01: If you've been holding your savings up against that 4% benchmark, that's not a mistake on your part.
3:44
SPEAKER_01: You've used the information that everyone's handing out, but that math is quietly treating your portfolio like it's alone in all the mix of this.
3:50
SPEAKER_01: And then it tells you only one of the three things you need to know, saying you don't have enough yet, or you can't spend what you actually could.
3:57
SPEAKER_01: Maybe it's telling you you'll be working longer than necessary.
3:59
SPEAKER_01: And here's another thing that the rule can't see.
4:01
SPEAKER_01: As a Nasdaq grows, spending doesn't necessarily move in tandem.
4:05
SPEAKER_01: The$5 million households I see don't automatically live a lifestyle that's double those that have two and a half million dollars saved.
4:11
SPEAKER_01: So the bigger your savings get, the further from a flat percentage this drifts from your actual situation.
4:17
SPEAKER_01: So this is blind spot number one, that the rule can't see the income around your portfolio.
4:21
SPEAKER_01: That's where it stops being a math problem.
4:23
SPEAKER_01: Say, let's go back to that old map.
4:24
SPEAKER_01: Say it routes your trip at eight hours, while a better route would actually only take six.
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SPEAKER_01: The real cost isn't that you took two extra hours of driving, it's that you have two fewer hours at the destination.
4:34
SPEAKER_01: And in retirement, those aren't just hours or days.
4:37
SPEAKER_01: We talk in terms of years.
4:39
SPEAKER_01: And there's a name for this pattern called the one more year syndrome, where smart, disciplined people are treating their best years for dollars they may never spend, grinding towards a portfolio target, a rule of thumb handed them, and then arriving at the destination with fewer healthier years left to enjoy what they were building all along.
4:56
SPEAKER_01: Now, I'm not saying everybody ought to retire as early as possible.
4:59
SPEAKER_01: I'm saying that you deserve to know whether those extra years are actually necessary before you hand them over.
5:05
SPEAKER_01: A quick note if you want to see what the math looks like when it factors in all the variables instead of just one, I built you a sample financial plan linked in the description below called our retirement readiness roadmap, where it walks through a plan from start to finish for a fictional couple.
5:18
SPEAKER_01: But even if this 4% rule understood your income sources, it would still break for a second reason that nobody's talking about, because the rule will tell you how much to take out, but it doesn't say anything about where to take it from.
5:28
SPEAKER_01: One of the most common things we hear from people who worked with another advisor previously is that nobody explained the tax side.
5:34
SPEAKER_01: This flaw extends to our 4% benchmark.
5:37
SPEAKER_01: Let me show you two households that have the same$3.5 million saved for retirement.
5:41
SPEAKER_01: Both are married, both are 62 years old, both collecting$60,000 of Social Security per year, and nothing else is coming in.
5:48
SPEAKER_01: To support their ideal lifestyle, both are wanting to take an additional$100,000 of income.
5:52
SPEAKER_01: To keep it clean, I'm assuming just federal income taxes instead of state ones as well.
5:57
SPEAKER_01: At first glance, these are nearly identical retirements.
5:59
SPEAKER_01: Household A will pull$100,000 from a traditional IRA.
6:03
SPEAKER_01: And as you know, every dollar of that comes out as ordinary income.
6:06
SPEAKER_01: But it causes a domino effect.
6:08
SPEAKER_01: As that IRA income lands onto their tax return, the tax code also starts pulling their Social Security income on with it, with about$51,000 of benefits now becoming taxable.
6:18
SPEAKER_01: That one withdrawal caused two tax events.
6:20
SPEAKER_01: Run it through all this year's tax brackets and deductions, and that single decision costs this couple about$15,600 in federal taxes.
6:29
SPEAKER_01: And here's what makes that number sting.
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SPEAKER_01: Without the IRA withdrawal, their federal tax bill would have been nearly zero.
6:34
SPEAKER_01: Contrast that scenario with household B that pulls the same$100,000 completely from a Roth IRA.
6:40
SPEAKER_01: Qualified Roth dollars don't land on the return as income, so it's not stacking, meaning the Social Security income remains untaxed, so they keep the full$100,000.
6:49
SPEAKER_01: It's the same portfolio and the same withdrawal rate, but it's the$15,600 gap in between what these two households actually get to spend in one year.
6:58
SPEAKER_01: Now, of course, this isn't advice on what account you should personally pull from, but it serves to contrast these two scenarios to show what the 4% rule casually overlooks.
7:07
SPEAKER_01: And honestly, that's just the beginning.
7:09
SPEAKER_01: Just around the corner, these households have to start considering Medicare surcharges beginning at their age 63, since that's when income starts being measured to match your Medicare premiums at age 65.
7:20
SPEAKER_01: If we push the same habit up the income scale, it means that we're seeing bigger withdrawals, bigger tax brackets, and bigger required minimum distribution starting in your 70s, where each dollar starts costing more and more and could be also adding up to those Medicare surcharge premiums on top.
7:35
SPEAKER_01: There's one more wrinkle that shouldn't be ignored where a surviving spouse will run this exact same math on single filer households, which in those tax brackets sit far lower.
7:44
SPEAKER_01: That same income that keeps this couple clear of Irma surcharges can automatically cause a single filer to suddenly be paying thousands of dollars per year in additional premiums costs with the exact same coverage.
7:55
SPEAKER_01: Zooming out, you can see how the 4% rule is only answering one question.
7:59
SPEAKER_01: Will the money last?
8:00
SPEAKER_01: It's not answering the question you actually care about, which is how much of it do I actually get to keep and use?
8:05
SPEAKER_01: That's blind spot number two.
8:07
SPEAKER_01: The rule cannot see the taxes inside your portfolio.
8:10
SPEAKER_01: And since your savings sit across three tax buckets, being pre-tax, Roth, and taxable brokerage, this blind spot alone decides what your retirement feels like.
8:18
SPEAKER_01: Now, the third flaw to the 4% rule is kind of ironic because it makes you both too cautious and too careless at the same time.
8:25
SPEAKER_01: It assumes you're going to spend the same amount, adjusted for inflation every single year for three decades.
8:30
SPEAKER_01: As if the 65-year-old version of you and the 90-year-old version of you want the exact same lifestyle.
8:35
SPEAKER_01: That's not how anyone I've ever worked with actually wants to live.
8:38
SPEAKER_01: You've probably heard of the go-go slogo and no go years, where the go-go years, roughly referred to as the mid-60s through the mid-70s, are when the travel happens, the projects happen, the time with family occurs, because you have the health and energy for all of it.
8:52
SPEAKER_01: Naturally, most people's mind andor bodies naturally slow.
8:56
SPEAKER_01: The trips will get shorter and closer to home, and just day-to-day spending steps down a bit.
9:01
SPEAKER_01: And later it'll step down further as you age, with one big exception being healthcare costs, which tend to climb up the older we get.
9:08
SPEAKER_01: And this isn't just my observation.
9:10
SPEAKER_01: Retirement analyst David Blanchett mapped how real retiree spending moves over time, and the shape even has a name, the retirement smile, where people are spending higher amounts early in retirement, lower through the middle, rising as costs come in towards the end of life.
9:24
SPEAKER_01: Let me show you what this actually looks like across three different retirement plans because this is where a flat 4% rule becomes really obvious.
9:31
SPEAKER_01: Here's the first client I'll show, which I'll just refer to as Household A.
9:34
SPEAKER_01: Early in her retirement, her withdrawal rate gradually rises as she phases out of work and actually peaks at just shy of 7%.
9:41
SPEAKER_01: Later, it falls to around 2.5% as her lifestyle changes and the portfolio has had more time to grow.
9:47
SPEAKER_01: Then towards the end of life, it actually spikes to around 6% of a withdrawal rate as we account for potential long-term care expenses.
9:54
SPEAKER_01: So already you're seeing how one household can move from well above 4% and below it and back up again.
9:59
SPEAKER_01: Now let's look at a completely different household we'll call household B.
10:02
SPEAKER_01: They're intentionally spending more during their go-go years while they're healthy enough to enjoy it.
10:06
SPEAKER_01: You might notice there's this one unusual year where the withdrawal rate drops dramatically.
10:10
SPEAKER_01: That's because in their scenario they're selling off one of their pieces of real estate, and those proceeds will temporarily reduce what they need from their portfolio.
10:16
SPEAKER_01: Nothing's wrong from the plan, it's just the source of their spending in that particular year changed.
10:21
SPEAKER_01: And now let's look at household C.
10:23
SPEAKER_01: Again, you'll see a completely different shape.
10:25
SPEAKER_01: That large spike comes at age 62 when they intend to purchase property in an aging-in-place community.
10:31
SPEAKER_01: Then later in retirement, there are years where the portfolio withdrawal rate is assumed to be less than half of 1%.
10:36
SPEAKER_01: And eventually withdrawals begin climbing again as we account for those end-of-life long-term care costs.
10:41
SPEAKER_01: Now, looking at all three together, these are three different households.
10:45
SPEAKER_01: And while there are certainly common themes, the timing and magnitude are completely personal to each.
10:50
SPEAKER_01: And that's the point.
10:50
SPEAKER_01: Real life is lumpy.
10:52
SPEAKER_01: People retire at different times, and income sources will turn on and off.
10:55
SPEAKER_01: Real estate may get sold, big purchases will happen, spending patterns change.
10:59
SPEAKER_01: And that's the distinction I want you to remember is that the withdrawal rate shouldn't dictate the plan.
11:04
SPEAKER_01: The plan should dictate the withdrawal rate.
11:06
SPEAKER_01: Because once you build around the life you actually intend to live, 4% stops being the answer.
11:11
SPEAKER_01: It's just a number on an ambiguous chart.
11:14
SPEAKER_01: And that's blind spot number three.
11:15
SPEAKER_01: The rule cannot see the spending your portfolio is actually there to fund.
11:19
SPEAKER_01: Because the rule wasn't designed to model how a person actually lives, just to stress test whether a portfolio will survive.
11:25
SPEAKER_01: So it's not a lifestyle plan.
11:26
SPEAKER_01: And this is exactly what I map out in that sample plan in the description you can access that shows how both of those last two flaws are mapped out on paper.
11:33
SPEAKER_01: The couple ended has that spending modeled in stages instead of a flat line and every withdrawal sequence by account.
11:40
SPEAKER_01: So if you want to see it, go ahead and grab it in the description.
11:42
SPEAKER_01: So if the rule can't see your income, your taxes, or your spending, why does everybody keep repeating it?
11:48
SPEAKER_01: Let's go back to that paper map again.
11:49
SPEAKER_01: A printed map can be handed to a million people, and the map maker doesn't need to know where any of them are going to start or where they're headed or what they even want out of the trip.
11:58
SPEAKER_01: It's just one product with infinite copies.
12:00
SPEAKER_01: The 4% rule survives because it distributes like a printed map.
12:04
SPEAKER_01: It's useful for retirement calculators, which have no idea what's on the other side of the screen.
12:08
SPEAKER_01: It just has one input and will give you one output.
12:11
SPEAKER_01: You can plug in a portfolio, apply a percentage, and get an easy number, but it's blind to these flaws.
12:16
SPEAKER_01: Makes it especially useful for financial media too.
12:18
SPEAKER_01: A headline to the tune of, here's how much the 4% rule says you need to retire is catchy.
12:23
SPEAKER_01: A headline saying your sustainable spending depends on a dozen variables specific to your household doesn't have a great ring to it.
12:30
SPEAKER_01: But it's also useful when an advisor wants to give a client a quick and easy answer.
12:34
SPEAKER_01: Not to mention that this industry is notorious for compliance that pushes everything towards the conservative end, which is reasonable right up until the conservative by default starts to quietly cost people years of their life.
12:45
SPEAKER_01: And this happens the most when advisors want to jump straight to how to manage your portfolio, which may include a fixed withdrawal rate to plan around.
12:52
SPEAKER_01: They may never actually ask what the money was for.
12:54
SPEAKER_01: And in our opinion, that feels a bit backwards.
12:56
SPEAKER_01: We would prefer to understand first the life you're building around, your purpose, engineer a plan to support that, and then apply it to your portfolio.
13:05
SPEAKER_01: But here's the part I want you to think about.
13:06
SPEAKER_01: Think about who you had to become in order to have the savings you're looking at today.
13:10
SPEAKER_01: You need to be careful, reasonable, having the kind of discipline that says we're not spending people.
13:15
SPEAKER_01: We live within our means.
13:16
SPEAKER_01: And for that person, the 4% rule stops being math, but becomes more like permission to spend.
13:20
SPEAKER_01: One might say that 4% of a portfolio is$100,000 they can spend.
13:25
SPEAKER_01: So that must be the responsible amount.
13:27
SPEAKER_01: The rule hands you a number that feels official, and many times it happens to agree with the echo chamber in your head, which you want to hear, which is the instinct to be careful, don't touch the money, and continue to save.
13:38
SPEAKER_01: Unfortunately, for many people with substantial savings, running out of money isn't the only risk worth planning around.
13:43
SPEAKER_01: It's also unnecessarily underspending in the retirement that they spent decades building.
13:47
SPEAKER_01: What the rule really does is give their anxiety a professional-looking framework.
13:51
SPEAKER_01: It gives people the sense that they're preventing the fear of going broke before they croak, even though most people would say they don't want to be the richest person in the nursing home.
13:59
SPEAKER_01: The rule only guards against one of those problems.
14:02
SPEAKER_01: So by now you can tell that the real problem was never that the 4% rule is the wrong number and some other number is the right number.
14:07
SPEAKER_01: The problem is how the question is framed itself.
14:10
SPEAKER_01: Because the old framing asks, what percentage can I withdraw?
14:13
SPEAKER_01: The new question should be, what can our actual retirement plan sustainably support?
14:18
SPEAKER_01: It's the same money, it's just a completely different conversation.
14:21
SPEAKER_01: And the old question stares at just the account balance.
14:23
SPEAKER_01: The new one factors in the three variables the 4% rule overlooks, being the income, taxes, and spending, so it can produce an answer that's tailored to you.
14:31
SPEAKER_01: Now, some of you are probably thinking, fine, I'll just get a better calculator or software.
14:36
SPEAKER_01: And modern planning software is genuinely powerful.
14:38
SPEAKER_01: We use it every week.
14:39
SPEAKER_01: It can model scenarios, run the tax math, test retirement dates, and stress test a plan against a thousand scenarios.
14:45
SPEAKER_01: But a good GPS doesn't automatically make a good driver.
14:48
SPEAKER_01: The software can see the road, it just can't supply the judgment of an experienced driver.
14:52
SPEAKER_01: A software tool won't tell you what questions you forgot to ask or what assumptions are quietly carrying the entire plan.
14:58
SPEAKER_01: And here's what it also can't do is pick the right route.
15:01
SPEAKER_01: Because the best route is not automatically the fastest one.
15:04
SPEAKER_01: We feel that a good plan isn't a race to the mathematically perfect answer, but that there's a set of intentional trade-offs that we need to make chosen on purpose.
15:11
SPEAKER_01: So here's where I'd encourage you to start tonight.
15:13
SPEAKER_01: Not building your whole plan from scratch, but starting with three lists that each have to do with the variables that the rule can't see.
15:20
SPEAKER_01: First, address income.
15:21
SPEAKER_01: Go to SSA.gov and pull the Social Security statement for you and your spouse if you have one.
15:26
SPEAKER_01: Write down the projected benefit at 62, full retirement age, and age 70.
15:30
SPEAKER_01: And there you get to start to see how much gets covered of your desired retirement spending before your portfolio has to step in.
15:36
SPEAKER_01: That'll start to show you where the 4% rule misses the mark.
15:39
SPEAKER_01: Second, taxes.
15:41
SPEAKER_01: List out your accounts by tax bucket.
15:43
SPEAKER_01: Most of you have most of your money in pre-tax assets.
15:45
SPEAKER_01: You may have some Roths and you might have some taxable assets as well.
15:48
SPEAKER_01: Once you see your personal split across these three buckets, you'll start to understand why one withdrawal rate can't tell the difference between these areas.
15:56
SPEAKER_01: And the difference is substantial.
15:57
SPEAKER_01: Third is spending.
15:58
SPEAKER_01: Write down what you spend today and answer it honestly.
16:01
SPEAKER_01: Is the 85-year-old version of you gonna live just like this?
16:05
SPEAKER_01: If the answer is no, you start to know the assumption underneath the 4% rule doesn't describe your situation.
16:10
SPEAKER_01: This whole exercise should take you about 30 minutes.
16:12
SPEAKER_01: Make these three lists, and if somewhere in the middle of it, a question pops up, something like, wait, is there something I'm missing?
16:18
SPEAKER_01: You know you're on the right track.
16:19
SPEAKER_01: That question is the beginning of an actual plan.
16:21
SPEAKER_01: Because this 4% rule will hand you a number, but a plan needs to build you a route along with backup options for events that are both in and out of your control.
16:30
SPEAKER_01: And here's your final step.
16:32
SPEAKER_01: If you're ready to see what a full retirement income strategy looks like, grab your copy of the sample retirement plan in the description below.
16:37
SPEAKER_01: It's the exact process I walk clients through all seven sessions from start to finish with income, taxes, and spending coordinated on paper.
16:45
SPEAKER_01: Start there.
16:46
SPEAKER_01: And if you're not ready to audit your plan yet, no problem.
16:49
SPEAKER_01: Because knowing the rule is wrong and actually replacing it are very different things.
16:53
SPEAKER_01: And that's what I'm going to cover in this video for you right here, where I walk you through the five systems that will make the hardest parts of retirement automatic.
17:00
SPEAKER_01: So the decisions that keep people stuck get made by the system instead of their own anxiety.
17:06
SPEAKER_01: Between that sample plan and this next video, you'll have the architecture to stop following cookie cutter rules and start building a plan for your specific life.