Safe Withdrawal Rates For Early Retirees: A Love-Hate Relationship

It is time to discuss safe withdrawal rates for early retirees, or what is sometimes known as “the 4% rule” – if the safe withdrawal rate is 4%.

The basic definition of the safe withdrawal rate is the share of your total net worth you can safely spend each year in retirement without depleting your net worth. In other words, spending X% of your net worth will allow you to sustain your chosen lifestyle into eternity.

The truth is, I both love and hate safe withdrawal rates.

As good a tool as it is to use towards financial independence for early retirees, as bad it is to keep you locked on an inefficient path towards financial independence.

Why I love safe withdrawal rates

1. Simple and easy to communicate

I love that safe withdrawal rates are easy to communicate. You can explain the concept in a single sentence as above, and it makes intuitive sense for almost everyone.

It is often used to calculate your financial independence number – the amount of money you need according to your safe withdrawal rate.

The math behind  is also quite simple for people with a basic understanding of math, and even if it isn’t, you just have to give them a simple formula, and they’ll be fine.

Of course, the original Trinity Study is a bit harder for some people to understand, but conceptually it makes sense. You model a portfolio against historical return data and find out what level of safe withdrawal rate would have worked.

2. Give you a real, tangible goal

I love that safe withdrawal rates makes financial independence tangible. It makes it easy to understand what it takes to become financially independent.

The safe withdrawal rate gives people a real goal. Getting a specific net worth number to strive for not only makes it tangible, but also achievable. For me, it was a great eye opener to know how much my net worth should be to sustain my current lifestyle.

Knowing your financial independence number also makes it possible to evaluate whether you could increase savings or income to achieve early retirement or financial independence earlier.

3. Scientifically proven

I love that the concept of safe withdrawal rates has been scientifically proven over and over again. It all started with the Trinity Study, but since then many people have studied safe withdrawal rates – both EarlyRetirementNow and Michael Kitces have made interesting contributions to the research.

They mostly all agree that safe withdrawal rates are real and useful, but they just disagree about the level it should be at.

4. Conservative

I love that safe withdrawal rates are like an old, grumpy man. They assume the worst case scenario.

The whole concept of safe withdrawal rates is that they are, you guessed it, safe!

Because they look at historical data going far back, they make sure that you do not deplete your net worth even during the worst crises. In fact, most financially independent people will experience a significant net worth increase even following the 4% rule.

Why I hate safe withdrawal rates

1. Too simple assumptions for early retirees

I hate safe withdrawal rates because it is based on overly simplistic assumptions that are not necessarily applicable for early retirees.

First, the 4% rule was initially based on retirees that have a lifespan of 30 years left. Of course, this does not apply to early retirees that (hopefully) have much more.

Second, it is based on a 50-100% stock and 0-50% bond allocation. In an ideal world, you could also factor in other asset classes such as peer-to-peer lending and real estate.

Third, no wait… this one is too important to not have its own headline.

2. Assume you will never earn a single cent again

I hate safe withdrawal rates because it assumes you will never earn a single cent again. It is based on the fact that retirees in their 60s sometimes are not as marketable to companies anymore, but for early retirees, this is a different story.

Nearly all of the early retirees I am following make money after becoming financially independent. All of the passion and creativity they throw on projects in early retirement will nearly always lead to some monetary gain.

Therefore, it is unrealistic that early retirees will never earn a single cent again.

This assumption of not earning anything is so critical because it drastically impacts your personal finance number if you just earn a little in early retirement.

For example, if I earn $800 every month in retirement, I will lower my personal finance number with 33% meaning that I can retire much sooner.

3. The endless discussion of what level they should be

I hate safe withdrawal rates because people get into endless discussions of what level they should be.

4%? 3%? 3.25%? 5%? 3.643254%?!

They truth is, nobody knows. Most people choose something in between 3-4%.

I see rational arguments for choosing all kinds of levels, but for me, the most important is to choose a level that you feel comfortable with… and then be ready to change it once you retire!

If it turns out that you hit many years of bad returns after retiring and the future just looks darker, then consider lowering your safe withdrawal rate.

If you ride on a tide of great returns and there’s no end in sight, you’ll probably be more than fine with your chosen safe withdrawal rate.

My point is, you should be ready to change your safe withdrawal rate as you go because your life and the world economy will change.

4. Based on historical data

I hate safe withdrawal rates because they are based on historical data.

We all know what to do when looking at investments and historical data. Throw it out of the window!

There’s no predicting the future based on the past in finance. Period.

5. Living expenses and income change over time

I hate safe withdrawal rates because they assume a static life. They assume that your living expenses and income will remain constant forever.

This is wrong. Your life will change many times before and after early retirement. You’ll get kids, you’ll get a promotion and salary increase, your medical bill will increase, you’ll buy fewer bottles in nightclubs, you’ll travel more, and so on.

The truth is that your expenses and income will change over time, and it is extremely hard to predict how. Therefore, your chosen safe withdrawal rate might be good for you today, but not tomorrow – especially when you are an early retiree with many years left to live in.

6. Don’t work in low-yield environments

I hate safe withdrawal rates because they might not work as well in low-yield environments. Recently, some criticism has emerged that safe withdrawal rates don’t work in low-yield environments.

However, we have had low-yield environments previously, and we don’t know if it is only temporary. Nonetheless, you should be extra cautious using the safe withdrawal rate these years – especially if you are close to retirement. If it really is a long-term trend we are facing, then of course, as with everything else, we will have to adjust.

7. Based on the worst case scenario

I both love and hate that safe withdrawal rates are based on a worst case scenario.

I understand why some people would like that. Some people hate working, and they want to be absolutely 100% certain that they will never have to work for money again.

The safe withdrawal rate is developed for these kinds of people. The ones that will never earn a single cent again and want to be sure that no financial downturn can change that – ever again.

I don’t like this way of thinking. I believe you should be flexible. You can work temporarily or decrease your spending slightly in bad financial times.

So, are safe withdrawal rates even relevant for you?

What you can use safe withdrawal rates for

The moral of the story? I believe that the concept of the safe withdrawal rate is an excellent tool for you to use towards and after achieving financial independence. It sets a clear goal to be obtained.

However, life is unpredictable.

You need to realize that things will change, and so will your safe withdrawal rate have to. If you have a flexible safe withdrawal rate that can remain stable in good times and decrease in bad times, you’ll be more than fine. You also need to be flexible with your life as an early retiree – also if it means that you occasionally will have to work for money again to remain financially independent.

If you can live with a little uncertainty in your life, you’ll be able to achieve financial independence a lot faster – if not, well, then you have to wait a bit longer to become financially independent.

As long as you are aware of the potential drawbacks of safe withdrawal rates, you’ll be more than fine using them.

Do I use it? Yes I do! My safe withdrawal rate is flexible. Right now, I target 4% because of simplicity, which is very conservative, given that I am sure I will work for money in early retirement.

Your turn: Do you love or hate safe withdrawal rates?