Breaking the 4% Rule

You’ve probably heard of the so-called “4% rule,” which says you shouldn’t take more than 4% of your portfolio annually if you want it to potentially last for 30 years. And in some cases, some people have narrowed it down to somewhere around 2%–3%.

Here’s something you need to know: this 4% rule isn’t really a rule—it’s more of a guideline. And because rules and guidelines are sometimes meant to be broken, in certain instances you might be able to take more—maybe even a lot more—than 4%.

Here’s a hypothetical example. Let’s say we have a single individual who wants to retire at age 64. He has $750,000 saved up and needs $5,000 of monthly income. If he took his Social Security at 64, he’d get $2,300 per month. That means he would need $2,700 per month from the portfolio, or about a 4.4% distribution rate on the $750,000. That’s not bad and may be workable. 

But what if this individual expects to live a long time? In that case it might be better to wait until age 70 to take his Social Security. By waiting, his benefit could grow to $3,500 per month, meaning at that point he could take a lot less from the portfolio—just $1,500 per month. But in the meantime, for the next six years, he has to take a $5,000/month gross income, which is an 8% distribution from his $750,000 portfolio.

You might be thinking that 8% is unsustainable. And you know what? You’re right. It is unsustainable over a long period of time. But the man in the example is only taking it for the next six years. After that, his distribution rate could go down dramatically because Social Security should be providing well over half of his income needs.

What this allows our hypothetical individual to do is to take a higher distribution rate now, for just a few years, in exchange for what may be a much lower distribution rate and higher Social Security benefits for the rest of his life. And this is done by ignoring the 4% rule and taking a lot more, at least for the first six years of retirement.

Of course in order for this to work, this person’s assumed longevity would have to become a reality. Obviously, if he postpones Social Security until age 70 and uses up extra money in his portfolio to buy him the time only to then die at age 71 or 72, he made the wrong choice. In that scenario, he would get less in Social Security payments and his heirs would lose out on the money he used for income.

But this example demonstrates in real terms why you sometimes need to ignore what passes for common wisdom and just focus on your own goals instead.