## 4 ways the 4 percent rule can work in Singapore

In our previous post, The 4 percent Rule for Financial Independence, we describe what the 4 percent rule is. In Does the 4 Percent Rule Work in Singapore, we also see how the 4 percent rule may not work well in practice. It looks like running a wealth machine is harder than building one! But here, let us show you 4 ways the 4 percent rule can work in Singapore!

To recap, these are the success rates of different levels of withdrawal from assets for retirement:

**Success rates of different withdrawal rates**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 65% | 45% | 31% | 23% | 17% |

4.5% | 76% | 67% | 42% | 31% | 25% |

4.0% | 86% | 69% | 54% | 43% | 35% |

3.5% | 92% | 80% | 68% | 57% | 47% |

3.0% | 97% | 89% | 80% | 71% | 62% |

2.5% | 99% | 96% | 91% | 82% | 76% |

2.0% | 100% | 99% | 96% | 96% | 87% |

It seems that what really works in Singapore is the 2 to 2.5 percent rule instead! This looks quite bleak for retirees in expensive Singapore. After a lifetime of saving, they can only have a retirement of scrimping because they need to make these savings last. However, it doesn’t have to be this way! In our previous post, we show how the 4% rule can work in Singapore by utilizing the CPF Special Account in retirement.

Here, we describe 3 other ways in which the 4 percent rule can work.

#### 1. Using the CPF Special Account as a Yield Shield

Our previous post was pretty dismal for those who believe a portfolio of stocks and bonds worth 25 times annual expenses is enough for retirement. However, by using the CPF Special Account (SA), we can retire on that amount and not worry! In fact, a nest egg mostly in the SA can last for 30 years in retirement, even after inflation adjustment! Here are the success rates for 4% withdrawal adjusted for inflation:

**Success rates of using the CPF Special Account**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

4.0%50% in CPF | 91% | 79% | 68% | 58% | 50% |

4.0%70% in CPF | 99% | 91% | 76% | 61% | 47% |

4.0%100% in CPF | 100% | 100% | 100% | 0% | 0% |

3.5%100% in CPF | 100% | 100% | 100% | 100% | 100% |

Unfortunately, leaving ** all** your money in the CPF SA is not possible now, with the rules for CPF Life. After transferring from the SA to the Retirement Account at age 55, no topping up of the SA is allowed. The SA at the retirement will consist of CPF contributions from work between ages 55 to 65, and interest earned. As the SA is a valuable resource for making sure money does not run out in retirement, due to the high interest paid on the account, please do not withdraw it to put in a bank deposit earning less than 4%!

The term ”Yield Shield” is a strategy used in the early part of retirement to protect retirement assets from Sequence of Returns Risk. This is the risk that investment losses early in retirement results in money running out during retirement. This happens even if investment returns are high later on, as these later returns cannot compensate for the early losses. We shall return to the yield shield in future posts, and test if it truly works in retirement. Many of the investment approaches based on “building passive income for life” are basically variants of the yield shield.

#### 2. Taking into account longevity (or the lack of it)

A 30 year retirement period is common in retirement financial planning, and the success rates of the 4 percent rule are tailored to this time horizon. In reality, the majority of us will not live such a long life. In fact, life expectancy drops off pretty fast after the age of 85, as we see in the survival rates to different ages below. For example, a male only a has 9.4% chance of surviving to age 95. A female, however, has a 19.59% chance of living to 95, hence the burden on retirement finances is greater.

**Survival rates to different ages by gender**

Age | 85(20 years) | 90(25 years) | 95(30 years) | 100(35 years) | 105(40 years) |
---|---|---|---|---|---|

Male | 45.37% | 25.54% | 9.40% | 1.86% | 0.07% |

Female | 61.55% | 40.60% | 19.59% | 5.70% | 0.44% |

Why does this matter? Obviously, we don’t need to worry about running out of money by a certain age if we don’t live so long! Everyone should plan for 20 years in retirement as a baseline, since 45% of the men and 62% of the women will live until 85. But beyond that, it is only the lucky (or unlucky) few who would be so blessed.

If we adjust the success rates of the different withdrawal rules using the survival rates to different ages by:

**Success Rate adjusted for life expectancy = 1****–**** ****(****1 – Success Rate****)**** ****x**** Survival Rate**

We get the following longevity adjusted success rates:

**Longevity adjusted success rates (Male)**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 84% | 86% | 94% | 99% | 100% |

4.5% | 89% | 92% | 95% | 99% | 100% |

4.0% | 93% | 92% | 96% | 99% | 100% |

3.5% | 97% | 95% | 97% | 99% | 100% |

3.0% | 99% | 97% | 98% | 99% | 100% |

2.5% | 100% | 99% | 99% | 100% | 100% |

2.0% | 100% | 100% | 100% | 100% | 100% |

**Longevity adjusted success rates (Female) **

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 79% | 78% | 86% | 96% | 100% |

4.5% | 85% | 86% | 89% | 96% | 100% |

4.0% | 91% | 87% | 91% | 97% | 100% |

3.5% | 95% | 92% | 94% | 98% | 100% |

3.0% | 98% | 96% | 96% | 99% | 100% |

2.5% | 99% | 98% | 98% | 99% | 100% |

2.0% | 100% | 100% | 99% | 100% | 100% |

For men, a 3.5% to 4% withdrawal rate is now possible, which is far better than the 2% withdrawal rate previously. For women, a 3.5% withdrawal rate would be safer, given their longer life expectancy. While accounting for longevity only results in small improvements in the safe withdrawal rate, remember that the difference between a 3.5% withdrawal rate and a 2% withdrawal rate is an 75% improvement in the standard of living during retirement! Also, a 3.5% withdrawal rate means that we only need to save 28-29 times annual expenses by retirement, compared to 50 times under a 2% withdrawal rule.

Of course, there is no free lunch. While the chances are that a higher withdrawal rate would be feasible once we account for longevity, we are taking on the additional risk of a long life. Running out of money and options at a ripe old age cannot be pleasant! So, better to have a withdrawal rate that is not just foolproof for 20 years, but also has a high chance of success over 25 to 30 years. Accounting for longevity only applies to retirees retiring at 65. Early retirees need to be far more conservative in withdrawing their money.

#### 3. Combining withdrawals with an annuity like CPF Life

Previously, when we wrote about CPF Life here and here, we argued that we should not really evaluate CPF Life, or any annuity for that matter, as an investment using a Return on Investment (ROI), or a Internal Rate of Return (IRR). This is because its main purpose is to act as a hedge against longevity risk. Let’s take a look at how that hedge can work in practice.

Suppose that we have a retirement nest egg of $500,000. At a 4% withdrawal rate, we would withdraw $20,000 a year, adjusted for inflation. The chance of this succeeding over a 30-year retirement period is only 54%.

However, let’s assume that you can put half of the initial $500,000 into an inflation adjusted annuity. The retirement income from the annuity now has a 100% success rate, higher than the 54% from drawing down assets.

To put it another way, at the age of 95, starting from an initial withdrawal rate 4% adjusted for inflation, we would need an income of $36,000 year. This, unfortunately, only has 54% chance of success if we draw it from our assets. If, however, an annuity is now pays half of this amount, or $18,000, every year for sure, with the other half of $18,000 coming from our assets, the chance of success is now higher at:

**0.5 x 100%** (from annuity) + **0.5 x 54%** (from assets) = **77%**

Now, let’s take a person in Singapore who has half of his money in CPF Life, and the other half in a portfolio of stocks and bonds. How would he fare using the 4% rule? The table below shows the answers:

**Success rates for 50% in annuity (Male)**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 89% | 85% | 73% | 66% | 100% |

4.5% | 97% | 92% | 87% | 79% | 100% |

4.0% | 100% | 99% | 97% | 92% | 100% |

3.5% | 100% | 100% | 99% | 97% | 100% |

3.0% | 100% | 100% | 100% | 100% | 100% |

2.5% | 100% | 100% | 100% | 100% | 100% |

2.0% | 100% | 100% | 100% | 100% | 100% |

**Success rates for 50% in annuity (Female)**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 83% | 72% | 65% | 61% | 58% |

4.5% | 93% | 86% | 79% | 74% | 71% |

4.0% | 99% | 96% | 92% | 92% | 85% |

3.5% | 100% | 100% | 99% | 99% | 96% |

3.0% | 100% | 100% | 100% | 99% | 98% |

2.5% | 100% | 100% | 100% | 100% | 100% |

2.0% | 100% | 100% | 100% | 100% | 100% |

The 4 percent rule is a lot more likely to succeed when paired with an annuity like CPF Life. Because the annuitization rate of CPF Life is 6.5%, it allows us to draw less than 4% from the remaining assets, hence increasing the likelihood of success for an overall 4% rate of withdrawal from all assets.

However, the proportion put into the annuity is critical. While it would be rational for a person with no wish to leave a bequest, and who prefers a steady stream of income over his remaining life, to put all his money into an annuity, in reality, without a mandatory scheme like CPF Life, the experience from other countries is that people only put 10% to 25% of their assets into an annuity. As the proportion allocated to the annuity shrinks, the chances of success will likewise fall.

If we only put a third of our assets into the annuity, the chance of the 4 percent rule succeeding is lower:

**Success rates for 33.3% in annuity (Male)**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 78% | 65% | 56% | 51% | 47% |

4.5% | 91% | 82% | 73% | 66% | 61% |

4.0% | 96% | 89% | 82% | 76% | 71% |

3.5% | 99% | 98% | 96% | 91% | 88% |

3.0% | 100% | 99% | 99% | 98% | 95% |

2.5% | 100% | 100% | 100% | 100% | 100% |

2.0% | 100% | 100% | 100% | 100% | 100% |

S**uccess rates for 33.3% in annuity (Female)**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 77% | 63% | 54% | 48% | 44% |

4.5% | 85% | 79% | 63% | 57% | 52% |

4.0% | 96% | 89% | 81% | 75% | 69% |

3.5% | 98% | 94% | 89% | 85% | 80% |

3.0% | 100% | 99% | 98% | 98% | 94% |

2.5% | 100% | 100% | 100% | 100% | 100% |

2.0% | 100% | 100% | 100% | 100% | 100% |

Without a healthy safety buffer of an annuity, the safe withdrawal rate needs to be reduced by 0.5%. This presents a dilemma, as retirees may have a bequest motive, and also need to have their assets for emergencies. Hence, while annuities are a must, it is likely not enough will be purchased to guarantee retirement security. Furthermore, just like taking into account longevity, this does not work for early retirees, as purchasing an annuity earlier in life can be prohibitively expensive.

#### 4. Adjusting withdrawals and spending when asset returns are poor

Another way the 4 percent can work is through managing the withdrawals and spending when the asset returns are poor. This means we will adjust our spending downwards in a stock market downturn, to preserve the value of the portfolio. In an upturn, we have the flexibility of adjusting withdrawals and spending back to the 4 percent rule or even higher.

However, many spending rule adjustments do not really work. One common rule is not to adjust for inflation in the years when the asset portfolio returns are poor. This does not work since this adjustment is only 2% to the amount of withdrawals required. How does this help when the portfolio asset values fall by 25% or more?

Other rules with better success adjust the withdrawal and spending amounts more significantly. For example, the “ceiling and floor” rules adjusts spending from 4% to 3% in a downturn (and to 5% in an upturn). This means that the standard of living in retirement may need to be cut by 25% in a downturn.

The “endowment” rule sets the withdrawal amount using the strict 4 percent rule for a portion of the assets, with withdrawal on the other portion set as a percentage of the current assets. An example would be to withdraw using the 4 percent rule from 50% of the assets, and using a fixed 4% of the other half. The 4% withdrawal from the other half will then go up and down according to the asset value. If the value of the portfolio drops sharply, this part of the withdrawals will also fall in line with it. Under this rule, the standard of living in retirement may need to fall by 50% at times.

Here, 75% of the assets are subject to a strict 4 percent withdrawal rule, and 25% being flexible. This means the standard of living in retirement may fall by 25% to make the money last.

How do the results look like? The success rates are shown following:

**Success rates of adjusting withdrawals and spending in downturns**

Withdrawal Rate | 20 years | 25 years | 30 years | 35 years | 40 years |
---|---|---|---|---|---|

5.0% | 80% | 69% | 41% | 30% | 22% |

4.5% | 88% | 71% | 54% | 41% | 32% |

4.0% | 94% | 81% | 68% | 55% | 44% |

3.5% | 97% | 90% | 79% | 69% | 59% |

3.0% | 99% | 96% | 89% | 81% | 73% |

2.5% | 100% | 99% | 95% | 90% | 84% |

2.0% | 100% | 100% | 99% | 97% | 93% |

Having flexibility in withdrawals and spending according to the returns on the asset portfolio allows us to raise the withdrawals by roughly 0.5% a year, i.e. from 3% previously to be safe for 20 years, to 3.5%. Surprisingly, the impact is not large for the Singapore context, compared to what we see in the research literature.

**Conclusions**

After all these examples and results, what can we conclude? We have looked at 4 different ways in which the 4 percent rule for financial independence can work. However, in the Singapore context, they all fall a little short. This is because the volatility in the Singapore stock market is higher than in the US, or G7. This acts as a drag on returns (we use an average annual return of 5.07%, plus 2.8% dividend yield). Hence, any adjustments we can make to portfolio management or spending, does not work that well.

What we can conclude is that the safest ways to make the 4 percent rule work in Singapore is not to depend on the stock market completely! Using the CPF Special Account, or CPF Life, are ways to ensure that money never runs out in retirement.

While this may be reassuring for retirees at the end of a long career, it doesn’t bode well for the early retirement folks, who would not have access to the CPF Special Account or CPF Life yet, nor can they depend on longevity risk doing the work for them. So we will continue to look at other ways and methods to make retirement finances work. Stay tuned!

#### Further reading

On safe withdrawal rates: Early Retirement Now! blog

On spending rules: Wade Pfau (2017) *How Much Can I Spend in Retirement? : A Guide to Investment-Based Retirement Income Strategies*

On using annuities: Moshe Milevsky (2015) *Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income for Life*

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