Invest1 publisher2 min readPublished
Butler professor's 'flexible 3%' rule trades a quarter of starting income for fewer failed retirements
Butler's Bryan Foltice says a 'flexible 3%' withdrawal rule fails less often than the 4% rule in long retirements, on a quarter less starting income. For clients retiring in their 40s, the lower draw buys a plan that can be restarted if they outlive it.
The Investor · Invest desk
Drafted by a language model from the sources cited here and checked against its claim ledger before publication. How we use AISend a correction
What happened
- Foltice said the FIRE movement partly prompted the research, because a retirement running from age 45 to 95 raises the risk of failure under the 4% rule.
- Foltice said advisers still have to fit taxes and required minimum distributions around the rule, and that running it blindly would be naive.
- Charles Failla of Sovereign Financial Group called 4% a decent rule of thumb but a very distant second-best to a year-by-year cash-flow analysis.
- Alicia Fuller of Coastal 360 Capital Advisors said affluent clients often leave IRA money alone until required minimum distributions force withdrawals.
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Why it matters
- cost A client moving from 4% to 3% gives up a quarter of first-year income, and pays that up front whether or not the 4% plan would ever have failed.
- constraint Until failure rates and return assumptions are published, an adviser cannot say how much protection that quarter of income buys a 50-year retiree.
- decision For clients retiring in their 40s, whose horizon is double the zero-growth life of a 4% draw, the starting rate becomes a choice the adviser has to defend against that client's own horizon.
A portfolio that earns nothing and pays out 4% of its starting balance each year is empty in 25 years. A 3% draw lasts about 33 [3]. A 50-year retirement [2] is twice what the 4% draw covers without growth [4], so investment returns have to pay for the second half. "The failure rate that everyone really focuses on tends to go up higher as the time horizon increases," Foltice told Financial Planning [4].
The cost of the 3% rule is a first-year draw 25% smaller than the 4% rule's [1]. That quarter stays invested, and Foltice called it a "safe cushion that you would have for being able to take money out" [6]. The design also allows a restart. "It won't be as much as the fixed rate, on average, but it also means that if you outlive your time horizon, you can basically restart the process and continue getting income for it, and so that's how we came up with this 'flexible three' rule," he said [5].
American Banker's account of the research does not report failure rates for either rule, the return assumptions, or how the flexible rule sets income from year to year [1]. That leaves three readings once numbers appear. In the first, the 4% rule rarely fails even over 50 years, and the client has given up a quarter of starting income for decades to insure against a small risk. The second turns on the word flexible. A rule that takes 3% of whatever the portfolio is currently worth cannot run the account to zero. Its low failure rate would then come partly by construction, with the risk moved into years of thin income. In the third, which is Foltice's claim, the 3% rule holds up and becomes the better default for early retirees [1].
I think the third reading is the most likely for a client retiring in their 40s, since that horizon is double the zero-growth life of a 4% draw [4]. The view is wrong if a published failure table shows the 4% rule surviving 50-year horizons nearly as often as the 3% rule. It is also wrong if flexible-3% income in bad markets drops below what the client actually spends.
Failla builds the plan from a yearly cash-flow estimate instead, sorting money into buckets by time horizon, with conservative investments for near-term spending and more aggressive ones for later years [11]. "No one can really project with accuracy going out 10 or 15 years, so you update that once or twice a year, and you'll have a pretty good idea," Failla said [12].
What to watch
- Publication of Foltice's full results with failure rates by horizon for the fixed 4% and flexible 3% rules.
- Whether the flexible rule takes 3% of the current balance or of the starting balance, which decides whether its lower failure rate comes partly by construction.
- Whether the average income gap between the two rules stays near 25% over a 50-year run or widens in poor markets.