4% rule

[HanoiRocks]

Hi there. Thankyou for having me on the forum.

I have been thinking about investing recently after inheriting some money and have been reading about the famous 4% rule. I have been confused by the statement that goes something along the lines of "At no point since 1925 would anyone have run out of money over the next 30 years investing at that rate". Perhaps I'm just hung up on the wording but I think it is crucial. Is this implying that the funds have depleted, say from £100,000 to some point below that but not reached £0 yet, or is it implying that they have at least retained their vaule, in this case £100,000 or above? On another forum someone who seemed to have good credentials wrote,

"This is why no one should buy an annuity with their pension fund. Left in cash i.e. with no investment risk at all, £300,000 would pay out an index linked (currently 3.01%) income of £809 a month for 21 years before the fund was exhausted, invested in the 15 Yr Gilt (the most secure form of actual investment), 25 years, and in a broad spectrum of FTSE 100 companies currently returning an average of 3.95% 37 years before the cash ran out."

Is this person purely using indexes that will grow according to inflation and is no growth the reason the funds will exhaust themselves after the £809 a month drawdown? If so why would they even bother mentioning it as the 4% rule is supposed to be a safe return on a balanced investment portfolio even taking inflation into account, is it not? Why would this poster even suggest this kind of investment, which is just wiping your money away, albeit at least your not wasting your money on an annuity.

Thanks for any advice!

Michael

[RetireJapan]

Hi Michael

The 4% 'rule' is a rule of thumb. It says that a balanced portfolio of stocks and bonds (60-40) will not be depleted over the course of a thirty-year retirement if 4% a year is withdrawn (and the withdrawals increase with inflation). It does not say the value of the portfolio will be preserved.

However,

1. it is based on the US in the 20th Century (might be a special case)
2. it envisages a worst-case scenario

There are other rules of thumb. A 3.5% or 3% rule would be even more robust, as would withdrawing 4% of the value of the portfolio and not increasing the amount with inflation. You could also live off dividends and interest, which would not deplete the portfolio.

[HanoiRocks]

Thanks for the reply. Would you say then that a good balanced portfolio would let you take out 3% a year, with dividends and interest on top, and in all likelihood retain or increase its value?
Unfortunately, my parents both died just after reaching retirement age so I have some of what they would have been living off, about £300,000, or 45,000,000yen once I convert it, and maybe some more later. The way I was looking at it though was that if the 4% rule meant only that the funds would not be depleted, I might as well just spend it instead of letting it waste away for a bit longer than it otherwise would in a bank due to inflation. (Although that may not be the case in Japan..)

[RetireJapan]

Thanks for the reply. Would you say then that a good balanced portfolio would let you take out 3% a year, with dividends and interest on top, and in all likelihood retain or increase its value?

The way I was looking at it though was that if the 4% rule meant only that the funds would not be depleted, I might as well just spend it instead of letting it waste away for a bit longer than it otherwise would in a bank due to inflation. (Although that may not be the case in Japan..)

A balanced portfolio might grow at 4-5% a year above inflation (this is not a prediction). That means it might double in (real) value every 15 years or so.

Alternatively, dividends are currently 2-3% on index funds.

If you can live without the money, you could invest it and leave it to grow. Or leave it to grow while spending the dividends.

I would recommend doing some reading before making a decision. The free pdf and Millionaire Teacher on this page are much recommended: http://www.retirejapan.info/further-reading.html

Come back and ask questions here as they arise

[HanoiRocks]

Thank you very much for the reply retirejapan. Will definitely look at the furtherreading section. Cheers!

[sutebayashi]

Condolences for your parents both passing away so young. I also recently lost one of mine, a little too early...

Perhaps I should take this to another thread, but about the inheritance matter, which I have not had to deal with yet as my other parent is still fortunately healthy. But my parents started talking to me about what I could expect to inherit, when the time comes.

Then I told them that Japan still has inheritance and gift taxes. This was a headache for them as they do not want their hard earned wealth transferred to me, only to see a hefty chunk taxed away by the Japanese government. I feel the same, and would rather my siblings got any share that would be squandered to the Japanese government through me inheriting it while in scope of Japan inheritance tax.

Now I am looking into ways to (legally of course) avoid directly taking possession of the inheritance, which seems like it should alleviate the need to pay inheritance tax. This may be easier for us foreigners with parents overseas.

I guess the inheritance tax has just been hiked recently so perhaps there aren’t many readers with experience since, but if any one has any experiences they can share I’d be interested - even if it is just regarding the sort of paperwork that I gather has to be filed to the authorities here in case of inheritances. Perhaps on another thread though, sorry to hijack!

[HanoiRocks]

Thank you for the condolences, and to you too.

FWIW all I remember hearing about Japan's IHT laws (I was in in the UK when my second parent died, which is all that matters for IHT matters) was that they were quite generous compared to the UK, with each inheritor being taxed, as opposed to the UK where the deceased's estate is taxed. The more inheritors there are in Japan the less and less tax will be paid, whereas in the UK you pay the same amount of tax regardless.
Correct me if I'm wrong.

[RetireJapan]

FWIW all I remember hearing about Japan's IHT laws (I was in in the UK when my second parent died, which is all that matters for IHT matters) was that they were quite generous compared to the UK, with each inheritor being taxed, as opposed to the UK where the deceased's estate is taxed. The more inheritors there are in Japan the less and less tax will be paid, whereas in the UK you pay the same amount of tax regardless.
Correct me if I'm wrong.

In the UK I believe there is a very simple system: the first 325,0000 pounds is tax free, or the first 650,000 for a married couple, and the tax is 40% over that: http://www.bbc.com/news/business-29756520

We probably need to do a long blog post on this, but my current understanding of inheritance tax in Japan is as follows:

The first 30m is tax-free, plus an additional 6m per inheritor (the main family ones). Anything over this is subject to taxation in bands, starting at 10% and going up to 55% eventually on estates over 600m: http://www.tokyozeirishikai.or.jp/general/zei/souzoku/

I'm not sure I understand the tax calculation. I used to think it was calculated on the estate as a whole, and inheritors with Japan tax liabilities are charged a proportional amount. However, reading the article above I am less sure.

Funeral expenses and taxes already paid in other countries are deductible (assuming there is a tax treaty) and there are lots of loopholes. If you receive or will receive a large inhertance definitely consult a professional. You need to file in Japan within ten months of becoming aware of the inheritance.