My Comments: These comments from Dr. James Dahle resonated with me as a long-time financial planner. The 4% rule essentially says that if you take more than 4% annually from your retirement accounts, there’s a strong chance you’ll run out of money before you run out of life. The article may be a longer read than you want, but with people living longer and longer, 4% may now be too much to take each year especially with higher gas, food, and tax costs.

by James Dahle, MD / 23.07.27 / https://tinyurl.com/2kuw775c

The 4% Rule 

The 4% rule originated from a study conducted in the 1990s at Trinity University in Texas that became known as the Trinity Study. Before this study, some financial advisors had been advising retirees that they could withdraw 8% a year from their investment portfolio if it averaged 8% returns. The Trinity Study showed that the previous way of advising people was not a very safe way to ensure you don’t run out of money. The study shared a concept called “sequence of returns risk.” This risk arises when the portfolio has poor performance in its early years, coinciding with the retiree withdrawing funds, which could lead to them running out of money.

The study analyzed 30-year rolling periods from 1927 to the present. It found that if people only withdraw about 4% annually, adjusted for inflation each year, their portfolio is highly likely to last at least 30 years—even in the face of unfavorable market conditions like the dot.com crash, global financial crises, wars, and economic downturns. The 4% rule suggests that you need about 25 times your annual expenses to reach financial independence and to retire comfortably without the need for additional income.

Though some people strictly follow the 4% rule for retirement withdrawals, many follow the more flexible adjust-as-you-go strategy—which involves adjusting withdrawals based on market conditions and personal circumstances. The 4% rule really is more of a guideline for retirement planning, and it helps people estimate the amount they need to retire securely.

Pensions and the 4% Rule 

“Hi Dr. Dahle. First of all, thanks for all that you do. I have a question about pensions and how to evaluate them along with the 4% rule. The example I’m thinking through is this. At first, the pension will cover just about all expenses in retirement. Let’s say, expenses of $100,000 per year and a pension of $100,000 per year for simplicity and not taking taxes or Social Security into account. This starts out great, but the pension doesn’t adjust for inflation. So, over time there will need to be a draw from an investment portfolio. I’m trying to figure out how big that starting investment portfolio needs to be to supplement the pension for a safe retirement.

I have a couple ideas, neither of which is perfect but could possibly work, I think. One is to assume, let’s say, a 30-year retirement length. Calculate the present value of the pension, assuming average inflation, add that value to the current value of the portfolio, and see if 4% of that total is at least $100,000. The other is to calculate what $100,000 of living expenses will be 30 years from now assuming average inflation, take the difference between that number and the $100,000 from the pension, and see if 4% of the current investment portfolio is at least enough to cover that difference. Any thoughts on these ideas? Any ideas I haven’t thought of or anything else I’m forgetting?”

Are you an engineer or just an internist? Because you put a lot of thought into something that I don’t think a lot of people think a lot about. It’s cool that you’ll have a pension. Pensions are great. I typically don’t try to fold a pension or Social Security into your asset allocation. I think the right way to think about that is to have it subtract from your need for retirement income (so that you need a smaller portfolio because you have a pension or because you have Social Security or whatever) rather than trying to somehow monetize it and calculate its net present value. Obviously, if this pension that you’re going to get does not adjust to inflation, then you’re going to need more. Even if you only need to spend $100,000 a year, you’re going to need some sort of a portfolio.

How much do you need? Well, that’s a great question. I think you can calculate that out relatively easily. In the first year, you’re not going to need anything from the portfolio. The next year, you’ll need enough to keep up with inflation. Maybe it’s 3% or 4%. So, you need that portfolio to provide $3,000 or $4,000. The year after that, you’re going to need the portfolio to provide $6,000 or $8,000. You can calculate this out and determine how big of a portfolio you need. I think that’s what I would do. I would just assume a reasonable amount of returns. I tend to use 5% real in my long-term calculations, and you can just add all that up and see what you’d need over 30 years and just run the numbers that way. I don’t think I’d try to do what you’re doing. I think I’d just look at it as a separate amount.

The truth is, though, that Social Security might rescue you there. It may provide the difference that you will need in addition to that pension. But I think that’s the way I would run the numbers if I were going to run them. I think that’s the way most financial advisors would run them rather than trying to monetize the pension somehow.

Adjusting the 4% Rule 

“Hello, this is Alan from Los Angeles. I was wondering how I should adjust the 4% rule if most of my invested money is in a taxable account and not so much in tax-free or tax-deferred accounts. I also note that I’m mostly invested in index funds and ETFs.”

Good job on being invested mostly in index funds and on having tax-deferred, tax-free, and taxable accounts. It sounds like you’re doing a great job preparing for retirement. I would make no adjustments whatsoever to the 4% rule based on the fact that you have a taxable account. Remember, the 4% rule has to include your taxes just like it has to include any financial advisory fees. If you’re paying a financial advisor 1% a year, your 4% rule is now a 3% rule. That’s just the way it is. It’s the same thing with taxes, though. If you’re going to have to be paying 25% of your income in taxes in retirement, your 4% rule is now a 3% rule. Most retirees are spending significantly less than 25% of their retirement income on taxes, however.

If you’re investing in a taxable account, it’s possible that you will have very little of that money taxed. I’ll explain why. First of all, there’s a long-term capital gains bracket of 0% that’s pretty generous, especially for a married couple. Same thing as the qualified dividends rate. You can get a lot of that out at 0%. Plus, when you sell shares, you generally sell the highest basis shares. Only 10% of what you’re selling might be taxable income anyway. You’re paying long-term capital gains on $10,000 of a $100,000 withdrawal. That could easily be 0%, and even if it’s not, it’s only at 15%. Fifteen percent of 10% is like 2%. You have this incredibly low effective tax rate withdrawing from a taxable account.

Now, if you’ve nearly drained the taxable account and you’re selling shares that are almost entirely gains, then maybe you can get that up to 25%-ish or so, with state income taxes. But even so, it’s never going to be much more than that. You just have to pay for your taxes out of those 4% withdrawals. You wouldn’t change how you do that based on what type of account it is. Just recognize that your tax bill will be less so you can spend more money because you’re spending less on taxes. But it doesn’t really change how the 4% rule works.

Pay Down Debt vs. Invest

“Hey Jim, my name’s Mark and I have another pay-down-debt-vs-invest question. I’m a 40-year-old surgeon making approximately $500,000 a year, including $50,000 of 1099 income. I save approximately 18% to tax-protected retirement accounts and another 5%-10% in real estate syndications. I want to know how to best deploy some additional capital. I have no other debt than a $930,000 mortgage, which is a 30-year fixed at 3%. I would ideally like to pay my mortgage off in 15 years and have the option of going part-time. That requires me to pay an extra $35,000 a year in principal payments.

Because of the mortgage tax deductions on my personal and business income, it seems better to invest this money in taxable. My question is how to best invest this money while still having the option of paying everything off in 15 years. My asset allocation is currently 65% stocks, 10% bonds, and 25% real estate with a slight small cap value tilt. If I invest in taxable and keep my current allocation, I risk not having the cash to pay the mortgage when I want it. On the other hand, I could invest this money in a side fund with an asset allocation of 60-40 or 70-30 total stock market in a UniBond fund, for instance.

I’m not sure what the best plan is. Part of me wants to just keep it simple and maintain my overall asset allocation knowing that if I just stay the course, I’ll have enough in taxable even if the market is down. Another part of me thinks I don’t need to take this risk given my overall savings rate and I should just take the 3% tax-free return. At the end of the day, the more conservative side fund seemed like the best compromise. What do you think? If using a side fund, how would you invest in it? Anything else I’m missing here?”

We all deal with this. When are you going to pay down the debt? Most of us don’t want to have debt in retirement. Lots of us would love to be mortgage-free by mid-career, but we look at that and we go, “Shoot, if my investments can’t beat the interest rate of my debt, I have bigger problems.” And it’s true, you do. When Katie and I were thinking about getting rid of our debt for a couple of years, we invested instead. We invested in taxable and said, “OK, well, this will probably grow faster than our mortgage rate,” which I think was 2.75% or something. We started that taxable account. We invested in taxable, invested in taxable, invested in taxable. A couple of years later, it became silly for us to have a mortgage. It just didn’t make sense anymore. It was a trivial part of our life. We were making more money. The White Coat Investor was starting to make money. So, over the course of six months, we wrote two big checks and paid off our mortgage.

I suspect something like that will happen to you at some point down the road. You may never use this taxable account to pay off your mortgage. You may have a windfall from something else. Maybe you inherit some money; maybe your income goes up. Maybe you end up investing in a surgical center and end up selling it and that’s what you use to pay off your mortgage and you never actually touch this taxable account. I don’t think I would have a dedicated taxable account just for this goal. You could if you wanted to, but I think I would just fold it into my regular asset allocation and invest it in my taxable account until such a time that paying off that mortgage becomes a bigger priority for you.

At 50, I suspect it’ll be a bigger priority for you than it is at 40. Maybe you choose to liquidate some of it and pay off the mortgage. Maybe you just decide to start directing new money toward that because in 10 years time, maybe instead of making $500,000, maybe you’re making $900,000. All of a sudden, you’re looking at that mortgage, and the mortgage is down to $400,000 and you’re like, “I can just wipe this out” and you choose to do so. But I think it’s reasonable for now for you to continue to essentially invest on leverage. You have a mortgage and you have investments and that’s OK. It’s OK to have debt; it’s not the end of the world. You want to manage it, you want it to be a reasonable amount, you want to have a plan for it, but it’s not the end of the world to have a little bit of mortgage debt.

I think that’s what I’d do. I don’t think I’d have a dedicated 60-40 fund on the side. I think I’d just fold it into my overall asset allocation and what that works out to be—even if it’s all stocks in there. Even if maybe it’s down on that date when you want to be mortgage-free, heaven forbid, you’ve got to push that date back a year or something. Chances are you’re probably still going to come out ahead. That’s what I’d do. Good luck with your decision. There’s no wrong answer here. If you’re really not sure what to do, split the difference. Put half toward the mortgage and invest the other half.