To keep their nest eggs alive, millions of Americans, whether they know it or not, are following the advice of an unassuming number cruncher with an aeronautics degree from MIT, who is credited with figuring out how much money retirees can safely withdraw from their retirement accounts each year. Back in 1994, William P. Bengen, a former engineer turned financial planner, published an ambitious studyopens PDF file in the Journal of Financial Planning that pinpointed how much individuals should be able to withdraw each year from their retirement accounts without running out of funds. The financial planning industry is celebrating the 20th anniversary of Bengen’s research, which was released in October, 1994. Financial planners, brokerage firms and others in the financial industry have widely adopted his so-called four-percent rule. The cover article in this month’s Journal of Financial Planningopens PDF file is dedicated to the research and includes praise for the work from leading financial experts. Specifically, Bengen concluded what the maximum percentage of a retiree’s money that he/she could withdraw safely over a long retirement. If historic investment returns can be believed, anyone following his prescription for a financially healthy retirement shouldn’t run out of money for at least three decades.
To keep a nest egg alive for at least 30 years, Bengen said retirees should only withdraw 4.15% of their portfolio the first year. After this initial calculation, however, investors should discard that percentage forever. Instead, each year retirees would take the amount of the previous year’s withdrawal and increase it by the inflation rate. For instance, if you calculated your first yearly withdrawal at $40,000, and inflation during the next 12 months was three percent, you could safely pull out up to $41,200 during the second year. For the third year, you’d take $41,200 and adjust that by inflation, and so on. You’re probably thinking that 4.15 percent seems awfully skimpy. Bengen arrived at this figure after looking back at the most notorious bear markets of the 20th century, including those that struck during the Great Depression and World War II. If investors had followed Bengen’s withdrawal guidelines, their retirement portfolios would have also survived the dot-com bust. The safe withdrawal rate will be even lower for more conservative investors. Bengen based his withdrawal advice on a basic retirement portfolio that’s divided between intermediate government bonds (37%) and large-cap stocks (63%).