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The 4% Draw Down Theory

So the Canadian Financial Reddit group had an interesting discussion about what a retirement planning philosophy for  your Retirement Savings might be. The question was should you try to create a nest egg that you can live off without having to touch it (live off the interest or dividends) or do you create a block of money that you then “draw down” until it is gone? The answer of course is, it depends, however, then the discussion of the 4% draw down rule came into the discussion.

My simple understanding of the model would be that you attempt to create a pile of savings for your retirement $X and if you retire at age 65, you would then withdraw $X * (1/25) every year to live on. This seems to imply that you will only live for 25 years before you exhaust your funds, however, then you enter the much more interesting discussions about the investment mix of your Pile of Savings $X. I will leave that part of the discussion out for now (i.e. how much do you leave in the stock market, how much in Bonds, how much in GICs, etc.,), however, that is the much more spicy part of the discussion.

So if we assume you have $1.5 M saved by age 65 (good on you!), and you plan on drawing down 4% a year, however, your blob of money also gets 1% growth every year, you will have a lot of money left at age 90.

Savings Amount at 65$1,500,000.00
SavingsGrowth assumption after 651.00%
Amount to draw every year$60,000.00
AgeAmount Left
A simplistic table for 4% Draw Down of Retirement Savings

That Isn’t Right!

Before everyone jumps on me, this table does not take into consideration:

  1. Taxes, if this money lives in your RRSP.
  2. Cost of Living, however, if you make the assumption that your 4% draw down adjusts with the cost of living, then the scenario could reflect all your investment needs to do is outstrip Cost of Living by 1%
  3. Catastrophic expenditures (sudden illness and such)
  4. No significant debt load still in play (or other horrific debts)

I now invite my much smarter readers to point out the flaws in this model, to help me improve on this simplistic set of calculations.


You could read this revised version: The 4% Draw Down Theory (again), which is a little more on the point in terms of arithmetic.

Feel Free to Comment

  1. A couple of suggestions:

    The sequence of returns matters whenever you have cashflows. Someone who experiences strong negative early returns might see their money last a full decade less than someone who had strong early returns followed by strong negative returns.

    Expenses can be very hard to predict in retirement as you noted.

    There is no simple model that will work, but this is better than not having *any* idea and just winging it. I think what is most practical is to approach it much the same way as the approach to saving for retirement: have a basic plan, monitor and revise if necessary. If things work well initially, you might increase your spending (or peace of mind). If things start poorly, one might want to take that into consideration and possibly reduce expenses.

    The idea of a perfect plan being one in which your very last cheque bounces is cute, but it’s not prudent planning given the sequence of return risk and expense variability that is unknowable in advance.

    There are planning software programs out there that model different sequences of returns and spit out a “probability of success” for given portfolio and spending assumptions (normally based on 1000s of simulations), where success can be defined as “not running out of money based on certain spending requirements”. Up until a few years ago, even these were flawed because they used normal distributions of market returns (which predict market shocks happening like once every 30 years or whatever). New models allow for fat tails and are better still.

    In the end, they are all just models, but some models strike me as more prudent than others.

  2. The 4% ruel might be nice for any investments held out side of RRSP’s but that is it.
    The governments want their “deferred” taxes back starting with a mandatory 7.38% in the year you turn 71. You HAVE to start withdrawing from RRSP’s by 71 at the very latest. Every year after that the percentage mandated increases up to I believe 20% by the time you are 90 years of wisdom.
    Why this 4% scenario keeps getting mentioned for Canada is beyond me

    1. The minimum withdrawal rate @71 isn’t necessarily 7.8%. You can use the age of your spouse instead if they are younger than you are. In my case my spouse is 31 years younger than me so my initial withdrawal rate will be 2.0%.

  3. I learn the same… but what I let drive my passion is MY numbers, and they tell me even while accounting for market drops (a Major) one, money can still be made and markets go up. – Cheers.

  4. About the assumptions on market returns, i am 100% invested in equities and had an 8% average annual return from 2000 – 2012. And this year we’re up over 16% already.
    I agree, you cant throw out 2008, those things will continue to happen. But dividends throuout were steady, and that allows you a constant withdrawel.
    I think we will be able to withdraw about 4% in dividends, and another 1% in capital when we retire. And the portfolio should not shrink much over the long term. That’s what dividend investing gives you. Constant cashflow with growth to cover inflation.

    1. That sounds like an excellent model (markets willing), and it ends up mimicking the, “Get a big lump of money and just live off the income from it” model (effectively create your own pension for retirement).

  5. Minimal savings, no pension, or mortgage (we rent). Equally no debt, no house repair to pay for and we live a very simple pretty much hand to mouth existence. I used to worry about it, until i realised that worldwide this is how most people live. I am happy, healthy, have a life I adore and very few worries. I’m 40 next year and DH (much younger) and I will inherit (money in trust) enough for a deposit to buy a 2 bed place over the next couple of years that we can rent out to cover some of the mortgage and pay off the rest…so we hopefully shan’t be homeless. Tbh investments or pensions are worth jack shit in today’s financial climate. I’ve seen far too many older relatives lose their retirement or pension find in stock market or house price crashes, and I don’t plan on being another mug. We will however make sure we have at least a roof over our heads big enough for the two of us, and we will possibly inherit a house elsewhere if nursing home fees are not required (I don’t count on this though in any way!) I don’t work at the moment, and have FAR less earning power than DH, so we do pay for VERY good life insurance/critical illness cover!

  6. Although not a poplular opinion sometimes, I believe that most people who were about to retire in 2009 and claim that they can’t now due to 2008/2009 really couldn’t have or shouldn’t have retired anyway. But anyway …

    When in doubt, don’t reinvent the wheel. The base case would be to start with a benchmark of how long we might live. This can be done using actuarial and mortality data. Based on this we can start to benchmark a ROR/tap rate. The easiest way is to look at payout annuities and GMWBs from the big insurers. They got caught with their pants down at 5% so it was adjusted to 4%.
    The issue I run into all the time is that people think they need to go way conservative when they retire yet their time horizon is still 20-30 years. If people took a balanced approach, focused on tax efficiency; the outcome has to be positive.
    One thing I am seeing more and more are retirees reducing draw rates during market corrections and pulling dollars off their LOCs. When the market rebounds, the LOC is repaid. Interesting strategy.
    If you are interested in leaving assets to kids or charity or whatever, an insurance policy would habe been the way to go as well as LTC. Like it was mentioned, I believe these things will derail plans faster than anything else.

  7. Just a question, is the $Starting at $1.5 million if you’re retiring now and your expenses are $60,000. But what if I’m 40 and I’m not retiring for another 25 years.

    1. KEEEP SAVING!!!!!!! 🙂 You could take the model and take 1.5 Million multiply it by (1.03) to the Power of 25 and assume that is how much money you need? That is assuming inflation runs at 3 % year over year. With that number figure out how much you need to put away to get to THAT number. KEEEP SAVING!!!!

  8. A good thing to do would be to assume a much lower — at least by half! — savings amount. The majority of Canadians (99%) will never ever amass $1+ million in liquid assets at any age, let alone by 65.

    Also not factored in is the cost of portfolio management.

    The ‘4% Rule’ is outdated — even it’s creator states as much.
    A more current, and Canadian, model is available:
    The Real Retirement (Vettese & Morneau, 2013)


    1. Considering the portfolio is only growing 1% per annum in the example I would think the management fee has been factored in. In my view financial advisors are overrated. My RRSP CAGR was a miserable 1.7% for the 9 years I employed a financial advisor. Since I went DIY 5 1/2 years ago my CAGR increased to 15.5%. I use a dividend growth strategy. It’s more hands on but I wouldn’t have it any other way!

  9. Your scenario is flawed with respect to the 4% withdrawal amount. Because you fix the withdrawal at $60,000 your withdrawal percentage is actually increasing throughout the duration. In your example the 4% withdrawal in year one gradually increases to 28.29% at age 90.

    If instead you had fixed the withdrawal percentage at 4% of the portfolio your $60,000 withdrawal in the first year would have steadily grown to a $77,715 withdrawal at age 90. You would also have a remaining balance of $1,865,169 with this withdrawal rate!

    1. I’m sorry but my numbers are wrong. Because the portfolio return is only 1% and the withdrawal rate is 4% the actual $ withdrawals would decline from $60,000 in the first year to $28,008 at 90. The remaining balance would then be $672,201!

      I apologize for my first posting inaccuracies!

  10. What is inflation running at BCM?

    Drawing down 4% is fine, and long as your cost of living remains at a steady state as well. No guarantees. I think people should assume at least 3% inflation, minimum, in their calculations. 4% would be safe.

    That said, I think most investors who retire with $1.5 – $2 M in invested assets at whatever time of retirement, if they keep costs low, are just fine. Caveat: they must have no debt at the time of retirement (age regardless).


  11. Canadian Dividend Blogger

    The first time I saw this argument was in William Bernstein’s book “The Four Pillars of Investing” (2002), where he devotes a chapter to the subject. He compares a mix of bonds and equities invested in 1966, at the beginning of a 17 year brutal bear market, to see what withdrawal rate would allow your cash flow to survive for 30 years. He compared 4%, 5%, 6% and 7%, and the 4% withdrawal rate was the only one that allowed your capital to survive 30 years, and only with at least 25% stocks. Under no scenario did a 100% portfolio of bonds survive 30 years.

  12. That’s a pretty good income ($48,000 after tax in Ontario) for retirement, especially if you have a paid-off house. I don’t think you included any CPP or OAS either, did you? If so, then it means many people won’t need 1.5 MM to retire unless they want a pretty cushy lifestyle.

    If you bought $1,000,000 worth of annuities from RBC using registered funds, joint life, 25 year guarantee period, starting today at age 65 for buyer 63 for wife, you’d get an income of $4725 a month, pre-tax, which is 56,700 a year. (45,000 after tax in Ontario)

    So yes, I think your draw-down should work. I can’t imagine an annuity is giving away much more than it has to.

    I’m probably missing something so feel free to correct me! (I admit to some confusion about how it works if you try to buy an annuity with RRSP money, for instance. I’ve always assumed it would be bought with non-registered money when doing planning/guessing.)

      1. Hi, Michael,
        Yes, I knew my annuity example doesn’t have inflation factored in. I couldn’t find a quick calculator for an annuity with a moderate inflation rate like CPI. They are out there because I’ve priced them before.

        Our one DB from the olden days is also not indexed for inflation; many DBs now aren’t. And after watching some of older relatives with pensions not factored for inflation, who retired through the 80s, we know what that will mean.

        I don’t think I’d ever buy only an annuity in retirement, but around age 75, if one or both of us makes it that far, it might be something we’d consider. Which is more trust inspiring-an annuity or a financial advisor to control your portfolio if dementia is setting in? Not a pleasant possibility but not unlikely unfortunately for me. Maybe I can get the kids up to speed and have them take over for us. At least then if we get bilked it’ll stay with someone we love!

  13. I think the biggest question is whether you can expect to get a return of inflation plus 1%. How yo invest the money and what fees you pay play a big role in realistic return expectations. Another matter is whether you care if you run out of money before age 93.

    1. Right now every tin pot expert is saying that we are in another boom, and it will be easy to get Inflation +1% return (if not 10% a year), I am skeptical and wondering when the bears will come out on this love-fest in the markets.

      1. So, I guess I’m making the rounds now… lots of familiar commenters here.
        So can we all agree that the last few years have been rather a rough ride in the markets? Can it get worse, sure but at least most agree it’s been bad…
        So from my personal experience, being in generally Cdn equities alone these have been my own returns: 2004 +14%, 2005 +14%, 2006 +14%, 2007 +5%, 2008 -60%, 2009 +13%, 2010 +20%, 2011 -10%, 2012 +5%, 2013 +15% (ytd)… If you average them out for the 10yr period you get about 4.5%. if you exclude the 2008 year it works out to ~10%. Not sure if this helps any of you, but it tells me over the long haul I should expect to see 4-5% return annually. Now if I throw in market timing into the picture, and in years when the market does poorly as timing for when I inject lumps of money, borrowed or otherwise over that same 10 yr period… here it comes, our 10 yr average has been 13%. Bottom line is we are all different, and all in the end want the same thing, a decent retirement. Here’s hoping whatever the path we all get there – Cheers.

        1. Phil, that’s a very, um, optimistic point of view on the markets, but I must caution you that making statements like, “if we throw out 2008”, is fool-hardy. Major market “adjustments” seem to be happening in much shorter time frames (and seem to be of much greater size), given we had a major adjustment in 2001, etc., etc,.

          Am I being pessimistic to your optimist? Absolutely, however, I feel your mental model may not work for everyone, but I also applaud your comments too (i.e. I am not saying get lost, you are wrong, I like hearing ALL points of view, even if I don’t agree, it’s the only way I learn things).

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