An example would be:

Initial value of account - $1,000,000
Initial withdrawal at 4% - $40,000CD
rate - 7%
Inflation rate - 3.5%
After 1 year - balance - $1,000,000 + $70,000 - $40,000 = $1,030,000
After 2 years - balance - $1,030,000 + $72,100 - $41,400 = $1,060,700
After 3 years - balance = $1,092,100...
After 42 years - balance = $2,397,972
After 43 years - balance = $2,396,180

Notice that after 43 years, inflation has "caught up" to your rise in principal, and principal begins to decline.

While, this might seem OK, just change the CD rate to 6% and you start losing principal after 20 years and you run out of money in 41 years !



Thanks markr33 for taking the time to post this. It really made it clear to me. The 4% rule is a bit misleading, because you use 4% only the first year. In you example, the % withdrawn the second year moves up to 4.02%, then 4.04% on the third year and so on. That's something that always confused me, since I thought that 4% was meant to be applied every year.
(could you tell me the actual function you would enter in Excel to calculate this?)

Actually, the original poster asked if the 4% refers to the principal, or principal plus interest, etc. He/she asked if the withdrawal rate would be be defined as 0% if the interest would be larger than the money withdrawn. You answered yes. However, this is not true in your example. The first year, the interest is 70k and the amount withdrawn is 40k, and you still refer it as a 4% withdrawal. So you actually mean that the 4% refers to the principal.

So, if I understand correctly, 4% refers only to the first year, and it is on the principal. For the subsequent years, you add the inflation rate to your initial withdrawal, and you add the CD rate to your money in the bank.

If that's not correct, would someone correct me?

Could someone also tell me where does this 4% rule
come from? I mean what is the goal here? To have the amount in the bank not go down for 30-40 years, taking into account the inflation rate? What are the basic premises???

Personally, the ideal situation would be if the money would decline much earlier and be practically zero when I die, since, as far as I can tell, I won't need it afterward!

Patrick