Spending It Down: Decumulation and the 4% Rule

Decumulation simply means the spending-down phase of retirement -- the mirror image of accumulation, the saving-up phase you spent your working years in. The mental shift is large: for decades the goal was to add money and watch it grow; now the goal is to withdraw money at a pace that does not deplete the account too soon. Getting the withdrawal rate and the withdrawal ORDER right is what makes a portfolio last.

In 1994, financial planner William Bengen studied U.S. market history and asked: what is the highest amount a retiree could withdraw in year one, then adjust upward for inflation each year after, and still not run out of money over a 30-year retirement? His answer became the famous 4% rule. Withdraw 4% of your portfolio in the first year -- $40,000 on a $1,000,000 portfolio -- then increase that DOLLAR amount by inflation each year, regardless of what the market does. What the rule assumes matters: a roughly 30-year horizon, a balanced stock-and-bond portfolio, and U.S. historical returns. It is a useful planning anchor, not a guarantee. Longer retirements, lower future returns, or high fees can all push the safe rate lower; a flexible retiree who trims spending in bad years can often sustain more. Treat 4% as a sensible starting estimate you adjust to your own situation -- not a number carved in stone.

The single biggest threat to a new retiree is sequence-of-returns risk: the danger that a market crash hits in the FIRST few years of retirement, while you are withdrawing. The same average return delivered in a different ORDER can mean the difference between a portfolio that lasts and one that runs dry. Selling shares to fund living expenses during a downturn locks in losses you can never recover -- the exact mirror of why a crash early in your saving years is nearly harmless (you keep buying cheap). It is covered in depth as a concept earlier in this track; in retirement it becomes the central risk to manage.

Imagine two retirees, each starting with $1,000,000 and withdrawing $40,000 per year (rising with inflation). They experience the EXACT same set of annual returns over 30 years -- just in opposite order. Retiree A gets a string of bad years first; Retiree B gets the good years first. Despite identical average returns, Retiree A can run out of money while Retiree B dies with a fortune. The reason: when A sells shares during the early crash, those shares are gone and cannot participate in the eventual recovery. This is why many planners suggest holding one to three years of spending in cash or short-term bonds entering retirement -- so you can pause selling stocks during a downturn. That cash buffer is the practical defense against sequence-of-returns risk.

Tax-deferred accounts (traditional 401(k)s and IRAs) let your money grow untaxed for decades, but the IRS does not wait forever. Once you reach the required age -- the SECURE 2.0 Act raised it to the early-to-mid 70s, with a further increase scheduled later this decade -- you must take a Required Minimum Distribution (RMD) each year: a minimum amount the IRS forces you to withdraw and pay income tax on. The amount is your account balance divided by an IRS life-expectancy factor, so it rises as a percentage as you age. Miss an RMD and the penalty is steep -- historically a hefty excise tax on the amount you failed to withdraw (SECURE 2.0 reduced it, and reduces it further if you correct the mistake promptly). Roth IRAs have NO RMDs during the original owner's lifetime, which is one reason Roth accounts are often spent last. Verify the current RMD age and penalty at irs.gov before planning.

Why the order matters: every year a dollar stays inside a tax-sheltered account, its growth escapes tax. Spending your taxable brokerage first lets the tax-deferred and Roth accounts keep compounding shielded. Spending the Roth last squeezes the most tax-free growth out of your single best account. The exact sequence should bend to your tax bracket each year -- some retirees deliberately withdraw a little from the tax-deferred account in low-income early years to smooth out future RMDs -- but the default of taxable, then tax-deferred, then Roth is the sensible starting framework.

Dana retires at 65 with $1,000,000 split across her accounts. She applies the 4% rule for a first-year withdrawal: 4% of $1,000,000 = $40,000. Suppose she needs $52,000 to live on and also collects $12,000 a year from Social Security. The gap her portfolio must cover is $52,000 - $12,000 = $40,000 -- exactly her 4% figure, so her plan is on solid footing. Next year, inflation runs 3%. Under the 4% rule she does NOT recalculate 4% of the new balance; she takes last year's $40,000 and raises it by inflation: $40,000 x 1.03 = $41,200. She pulls that $41,200 from her taxable brokerage account first, leaving her tax-deferred and Roth accounts untouched to keep compounding. If the market had crashed that year, she would instead lean on her cash buffer to avoid selling stocks low -- her defense against sequence-of-returns risk.