The 4% retirement rule isn't dead (but your investment fees might kill it)

You've spent decades building your retirement nest egg. Now comes the moment of truth: how much can you actually withdraw each year without your money running out?

If you've researched retirement planning, you've probably heard of the famous 4% rule. Take out 4% in your first year, adjust for inflation annually, and your savings should last 30 years. Simple, right?

Here's what's puzzling: some retirees following this rule thrive, while others struggle or even run out of money. Same rule, same discipline, completely different outcomes. The question is, why?

The answer lies in a factor most people overlook when planning their retirement income.

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The 4% Retirement Rule: Still solid after all these years

The 4% rule, developed by financial planner William Bengen in 1994, has stood the test of time reasonably well. It's based on historical market data and assumes you can withdraw 4% of your portfolio value in the first year, then adjust that amount for inflation each year after.

For retirees today, this rule still makes sense as a starting point. It falls comfortably within the legal withdrawal range of 2.5% to 17.5% for living annuities, and it's built on the logical premise that you shouldn't withdraw more than your investments can sustainably generate over the long term.

But there's a critical assumption baked into the 4% rule that many people miss.

Fees: the hidden variable that changes everything

Let's get specific and assume you've saved up R5 million by the time you retire. Following the 4% rule, you'd plan to withdraw R200,000 in your first year, which is about R16,600 per month. Sounds reasonable, doesn't it?

But here's where things get interesting. The sustainability of that R200,000 withdrawal depends entirely on what else is coming out of your portfolio.

Scenario 1: High-cost living annuity provider

• Your withdrawal: R200,000
• Annual fees and costs: R125,000 (2.5%)
• Total leaving your portfolio: R325,000
• Your investments need to generate 6.5% returns just to break even

Scenario 2: Low-cost living annuity provider

• Your withdrawal: R200,000
• Annual fees and costs: R50,000 (1%)
• Total leaving your portfolio: R250,000
• Your investments need to generate 5% returns to break even

All else being equal, that seemingly small difference in costs means you need an extra 1.5% in investment returns every single year just to achieve the same retirement income.

The Golden Equation: the rule that really matters

At 10X, we think about sustainable withdrawals within a framework we call the golden equation:

Drawdowns + Fees + Inflation ≤ Investment Returns

This equation reveals why the 4% rule works for some people but not others. It's not just about the 4%. In fact, it's about everything else leaving your portfolio.

Consider this: if inflation is running at 5% and you're paying 2.5% in total costs, you need your investments to generate at least 11.5% returns just to maintain that 4% withdrawal rate in real terms. Miss that target, and you're slowly eating into your capital.

But if your costs are only 1%, you need just 10% returns for the same outcome. That 1.5% difference might not sound like much, but it's often the difference between a sustainable retirement and one where you're constantly worried about running out of money.

And the bigger problem is that fees compound against you

The immediate impact of high fees is significant, but the long-term effect is devastating. High costs don't just reduce your current income, they also systematically shrink your future options.

Let's follow our R5 million portfolio over 20 years, assuming similar market conditions but different cost structures:

High-cost scenario: Even with decent investment returns, high annual costs mean your portfolio might be worth around R5.3 million after 20 years of 4% withdrawals.

Low-cost scenario: The same investment returns, but with lower costs, could see your portfolio worth R7.3 million after the same period.

Twenty years into retirement, your 4% withdrawal capability would be:

• High-cost portfolio: R213,000 annually
• Low-cost portfolio: R293,000 annually

That's an extra R80,000 per year (R6,600 per month) purely because of the compounding effect of cost differences.

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A smarter strategy is to work backwards from what you keep

Instead of fixating on the 4% rule, here's a more practical approach:

Step 1: Minimise what's working against you

All else being equal, every rand you save in fees is a rand that can either be withdrawn as income or reinvested for future growth. We regularly see providers charging 2.5% or more in total annual costs. Getting those costs down should be your first priority.

Step 2: Use 4% as a baseline, not a law

With reasonable costs, the 4% rule becomes much more achievable. You might even find you can safely withdraw more during strong market years.

Step 3: Stay flexible with market conditions

Living annuities allow you to adjust your withdrawal rate annually between 2.5% and 17.5%. This flexibility is crucial:

• Strong market years: You might increase to 5-6%
• Weak market years: Drop to 3% or even 2.5% to preserve capital
• Average years: Stick close to your baseline

Step 4: Focus on what actually drives returns

Asset allocation determines roughly 90% of your investment returns over time. With lower costs eating less of your returns, you have more flexibility to optimise your portfolio mix based on your risk tolerance and time horizon.

The Living Annuity Advantage

Living annuities offer two crucial benefits for implementing a smart withdrawal strategy:

Cost control: You're not locked into high-fee providers. If you discover you're overpaying, you can switch without penalties.

Income flexibility: You can adjust your withdrawal rate annually based on your portfolio's performance and your changing needs. This means you're not stuck with a fixed percentage regardless of market conditions.

(and, if you need another reason to consider a living annuity, we should also mention you can leave you capital to nominated beneficiaries, which usually isn't the case with a life or guaranteed annuity)

Control what you can control (and you

The 4% rule isn't broken. It just assumes you're not undermining it with excessive costs. The retirees who struggle with the 4% rule often aren't failing because of the rule itself, but because high fees are quietly sabotaging their strategy.

Here's the reality:

• With high costs (2.5%+), even a 3% withdrawal rate might be unsustainable during poor market periods
• With reasonable costs (around 1%), you can likely achieve 4-5% sustainably
• With very low costs, you might safely withdraw 5-6% during favourable market conditions

The most successful retirees don't just blindly follow withdrawal rules. They optimise the factors they can actually control. Costs are the most controllable of these factors, and often the most impactful.

Remember, retirement planning isn't about finding the perfect formula. It's about understanding what drives your outcomes and making smart decisions around the factors you can influence.

Curious about how much your current fees might be impacting your retirement income? Our Cost Comparison Report shows you exactly what high costs could be costing you over time.

Want to discuss a withdrawal strategy that accounts for costs, market conditions, and your specific situation? Speak to one of our investment consultants for a no-obligation conversation about optimising your retirement income.