You Won’t Like Suze Orman’s Recent Retirement Advice. But It Might Serve You Well.

In case you don’t know who Suze Orman is, she’s a personal finance guru, having written multiple financial books that have sold more than 25 million copies worldwide. Thus, it’s worth hearing her out when she addresses an important topic such as retirement withdrawal strategies.

Last year she shocked some when she warned that the famous “4% rule” is “very dangerous” because “it doesn’t work anymore.” Here’s a closer look at the rule, why it’s problematic, and what you might do instead of using it.

Meet the 4% rule

The 4% rule was introduced back in 1994 by William Bengen, a financial advisor. Based on his calculations, he suggested that retirees could withdraw 4% from their nest egg in their first year of retirement and then adjust subsequent annual withdrawals for inflation.

The table below shows how much you’d get to withdraw in your first year of retirement, depending on the size of your nest egg:

Data source: author calculations.

So if you retired with, say, $600,000, you’d take out $24,000 in your first year of retirement. (This would be in addition to any other retirement income sources, such as Social Security, a pension, and/or an annuity.)

Now imagine that inflation is 3% in that first year, close to the long-term average rate of inflation. If so, you’d multiply your initial $24,000 withdrawal by 1.03, getting $24,720. That would be your withdrawal for year two. If inflation shoots up to 4.5% the next year, multiply $24,720 by 1.045, and you’ll arrive at $25,832 for your third year’s withdrawal.

What’s wrong with the 4% rule?

That 4% rule should seem fairly straightforward and easy to use. It has some serious flaws, though, in part because we’re all a little different. Consider:

Longevity

The 4% rule is supposed to give your nest egg a good chance of lasting for 30 years. That’s great, but note that many people are retiring in their early 60s these days, and many are living beyond 90, sometimes to 100 or beyond. Meanwhile, some people have strong likelihoods of living shorter-than-average lives. It’s worth taking your expected longevity into account when you think about adopting a 30-year plan.

Asset allocation

Bengen’s model initially assumed a 50-50 stock-bond mix (though many revisitations of it have used a 60-40 stock-bond mix). Opinions will differ on what the best asset allocation is for retirees, and there won’t be a one-size-fits-all answer. If you prefer, say, a 70-30 stock-bond mix, or, say, a 65-25-10 stock-bond-cash mix, the 4% rule is already not applicable to you. And many people will shift their allocations over time, too, perhaps starting overwhelmingly in stocks and boosting the bond portion as they age.

The allocation matters a lot, as stocks tend to grow faster than bonds, and a portfolio with a higher proportion of bonds may grow more slowly than one with more stocks. A stock-heavy portfolio, meanwhile, may be more volatile.

Timing

Timing is another matter. Imagine two retirees, each retiring with a $500,000 nest egg, but retiring at different times. If the stock market surges a year after the first one retires and it crashes a year after the second one retires, that will leave each retiree in a very different situation.

The one with a suddenly deflated nest egg will be expected to withdraw much more than 4% of their current nest egg, and the one with a much bigger nest egg will effectively be taking out much less than 4% of it. The one with the bad timing may end up depleting their nest egg too rapidly, while the one with good fortune may end up taking out much less than they could have.

Mr. Bengen actually revised his 4% rule over time, upping it to 4.5%, and a few years ago he suggested that a 5% initial withdrawal rate might be better.

What withdrawal strategy should you use instead of the 4% rule?

Those problematic factors are some of the reasons that Ms. Orman doesn’t love the 4% rule. She recommends planning to live into your mid-90s — just in case. After all, you don’t want to end up bucking your family’s trend, living to 95, and suffering because your retirement plan only covered you to age 80.

She also notes:

[T]here are a lot of moving pieces to make sure you never run out of money. As a very broad rule of thumb, if you start making withdrawals in your early 60s my advice is to aim to withdraw and spend no more than 3% or so of your account value in year one, and then adjust that amount for inflation each year. If you don’t start withdrawals until around age 70, 4% can work just fine. And if you have all your living costs covered by guaranteed income, more than 4% may be viable.

Withdrawing only 3% in your first year of retirement will give you a lot less to live on, but it may help your nest egg last longer. So think through the critical retirement-withdrawal-strategy issue very carefully as you craft your retirement plan. You may be well served by planning for the worst while hoping for the best. Don’t be afraid to consult a financial advisor, either.