Retirement Planning

4 Percent Retirement Rule – Is it Still Valid Today?

Published by Bob Gustafson

4 Percent Retirement Rule - Is it Still Valid Today?

You are about to retire and have created a nice retirement portfolio. But how do you ensure what you have saved will be enough money for your retirement? There is a well-known retirement spending strategy called the 4 percent rule. But is it still a valid strategy in today’s world?

Many saving for retirement ask key questions to help them prepare, such as:

  • How much money do I need to retire?
  • Will my money last my lifetime?
  • What if I have an unexpected expense?
  • How much can I withdraw every year so I don’t run out of money?

What is the 4 percent retirement rule?

The 4 percent rule is a retirement strategy that’s been around for a while. It’s a rule of thumb retirees can follow to determine how much you should withdraw from your investment portfolio annually. This rule states the retiree can withdraw four percent of investable assets per year and it will provide a steady income stream. It will also maintain an adequate account balance providing income for up to 30 years.

In other words, the four percent rule helps determine how much of your retirement savings you can use each year so you don’t run out of money. This is helpful for you to estimate how long your retirement portfolio may last. But like all things financial, there are a lot of factors that you need to take into consideration.

Challenges using the 4 percent rule

The 4% rule takes into consideration a lot of different factors but each year your situation may change for example:

  • Sources of income. You might choose to continue working. But you will also start receiving other sources of income such as social security benefits or possibly a pension.
  • Changes to your expenses. Costs will increase in areas such as healthcare. But others may decrease. But the changes aren’t the same. So, some years you may need to draw more money from your portfolio and others, less.
  • Taxes. The only certainty in life is death and taxes. And you have no control of either. What your tax rate in the future is unknown and depends on what types of retirement accounts you may have. Financial transactions can result in capital gains taxes. Or retirement accounts funded with pre-tax dollars will be taxed as ordinary income when withdrawn.
  • Market volatility. What happens to your portfolio if the market drops? Do you sell more stock to withdraw the 4 percent? But if you do, you have less stock now to help you recover when the market rises.
  • Inflation. The rule does allow you to increase your withdrawal rate to account for inflation. But knowing how much to withdraw can be a little more complicated. Do you increase your withdrawals by a flat 2% per year, the Federal Reserve’s target inflation rate? Or do you adjust your withdrawals in line with each year’s inflation rate? In other words, more aligned with the cost of living.

What is the right number?

With the lower interest environment we are in, coupled with the expectation that future stock market returns won’t be as robust as in the past, most experts have decreased the four percent suggestion.

Many financial advisors now recommend withdrawing less to start. Research from Morningstar suggests that 3.3 percent is the best amount for the current financial climate.

But there are many variations of these findings. For example, some say 3.3 percent with no inflation adjustment for the first 10 years, etc. It’s important not to get too caught up in the details of this rule. Why? Because there are other things to consider along with the withdrawal percentage.

We tell our clients that a good ballpark figure to use is three percent as it’s a more conservative amount but honestly a customized financial plan is a much better alternative to figure out how much you could or should take out each year. There are a number of other considerations as well such as delaying social security as long as you can, working longer and/or cutting expenses as much as possible. 

If you have any questions or concerns, contact us and we’ll walk you through how it pertains to your personal financial situation.

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