Does the 4% Rule Apply to Early Retirement?
If the 4% withdrawal rule was created with a 65 year old in mind, what happens when you want to retire earlier? How much would an early retiree have to reduce their withdrawal rate to accommodate a longer retirement? Research has been done that suggests that you don’t have to reduce the 4% withdrawal rate too dramatically, even for very young retirees.
People who have achieved financial independence early in life have at least two things in their favor: they still have the ability to go back to work if market conditions made it detrimental to withdraw, and they have a higher likelihood of better returns overall because of the longer investment period. Anything can happen over 10 years, or even 20 years, but with a 40+ year time horizon, investment averages are historically better.
A dividend-oriented portfolio might be able to distribute a 3% income stream in today’s market, and many dividends are increased regularly, which can offer an inflation adjustment on this income. If the you can live on a 3% withdrawal, it’s reasonable to think that a portfolio could be sustained no matter how long it was needed, with a little help from stock appreciation over time. This creates a guard rail of sorts, a minimum theoretically-safe withdrawal rate.
It gets tricky if the retiree’s money is tied up in IRAs (because of the age 59.5 rule), but there are several strategies that are available for taking early withdrawals without penalty.
While it might seem impossible to retire early, if you’re most of the way there you might be able to make it work with some supplemental income – we see retiring dentists speaking, consulting, or working in a dental office just a few days a month. Any income that you can produce is money that doesn’t have to be pulled out of the portfolio. The more money that stays in the portfolio, the more opportunity it has to grow. At the rate that early retirees tend to go back to some sort of work, you might consider “retiring” even earlier than planned with the idea of still working a little to supplement your income.
Getting out early is a giant step, not to be taken lightly. Investment returns, inflation, tax ramifications, spending needs and health insurance are just some of the variables and considerations. We would stress-test all assumptions before recommending an exit, but it’s exciting work and a thrill when the numbers say YES to making the leap.