This post considers how an increase in inflation
impacts the viability of the four percent rule. The basic financial scenario considered here
is a pessimistic one. It involves low
returns at the beginning of retirement and higher returns in subsequent years.
Question: Consider a worker who retirees with $500,000,
sets an initial disbursement at 4 percent of assets and links disbursements to
inflation.
Market returns are 6 percent
for the first four years followed by 9.0 percent per year for 11 years.
What is ending balance of the
account assuming inflation rates of 2.0, 3.0, 4.0, 5.0 and 6.0?
The Basic Spreadsheet
The basic spreadsheet with a
2.0 percent inflation rate assumption is presented below.
Scenario
One


Initial
Disbursement Rate

0.04


Inflation
Rate

0.02


Balance

Disbursement

Stock
Returns


0

$500,000

$20,000


1

$450,000

$20,400

0.06

2

$402,600

$20,808

0.06

3

$357,636

$21,224

0.06

4

$314,954

$21,649

0.06

5

$321,651

$22,082

0.09

6

$328,518

$22,523

0.09

7

$335,561

$22,974

0.09

8

$342,788

$23,433

0.09

9

$350,206

$23,902

0.09

10

$357,822

$24,380

0.09

11

$365,646

$24,867

0.09

12

$373,687

$25,365

0.09

13

$381,954

$25,872

0.09

14

$390,458

$26,390

0.09

Discussion of Spreadsheet:
The disbursement rate top
cell in input area is multiplied by initial balance $500,000 top row of chart
to get initial disbursement.
Subsequent disbursement is
(1+inf)*previous period disbursement.
Stock returns are in farright
column.
Balance is (1+return) *
previous balance) – previous disbursement
To obtain ending balance at
other inflation rates just input the other inflation rate and recalculate the spreadsheet.
The Impact of inflation on 401(k)
Balance
The chart below summarize the
impact of inflation on the 401(k) balance under the four percent rule under the
assumed financial scenario.
inflation
Rate

Ending
Balance

0.02

$399,210

0.03

$360,863

0.04

$319,403

0.05

$274,560

0.06

$226,042

The simulation reveals assets
fall sharply with an increase in inflation under this four percent rule and
under this financial scenario.
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