The 4% Rule For Retirement Withdrawals Explained
With so many financial gurus online, it’s easy to get misguided when figuring out how to save money for retirement. The wrong answer can lead a retiree to make costly financial decisions, possibly losing out on thousands of dollars and a setback on their retirement date.
So, with all the information out there on how to save for retirement, this article focuses on how much money you’ll truly need to save once you’re ready to settle down. This rule of thumb is called the 4% rule and will be discussed further below.
What Is The 4% Rule?
The 4% rule is based on the idea that retirees should withdraw the amount equal to 4 percent of their savings the year they retire and then adjust for inflation for the years that follow. The benefit of this rule relies on its simplicity. It provides an exact guideline that makes planning for retirement clean and easy.
The downside, however, is that the rule leaves little room for inflation. The simple fact of the matter is that the value of money changes as time goes on, so information based on set numbers can possibly be useless by the time you reach retirement. However, before jumping to conclusions, use this helpful guide to find out whether the 4% rule will work for you and your future retirement.
The History Of The 4% Rule
In 1994, financial advisor William Bengen used historical data on stock and bond returns to challenge the previous rule of withdrawing 5 percent yearly in retirement.
While conducting his research, Bengen used a 60/40 portfolio model, which is comprised of 60 percent equities and 40 percent bonds, comparing higher interest rates with current rates.
Bengen based his conclusion on half a century worth of market data, finding out that any imaginable economic scenario could allow for a 4 percent withdrawal during the year of retirement, with an adjustment for inflation for the subsequent years.
What The 4% Rule Forgets
The bottom line is this, the 4% rule does not account for situations that deviate from the conventions of the theory. And although William Bengen was diligent in his findings, the rule fails to include an inherent fact. A stiff, rigid rule is not fit to govern an economic landscape that is anything but stiff and rigid.
Variables That Don’t Fit The 4% Rule
Here are three variables that don’t fit the flat withdrawal rate of the 4% rule:
- Medical expenses: Even in our youth, we may find ourselves racking up medical bills that seem almost impossible to pay. And with the growing rate of chronic illnesses, there’s no telling how much one will allocate to medical expenses at an older age. And in all honesty, it is practically impossible to predict. Medical procedures vary drastically in cost. Another big factor that could impact the practicality of the 4% rule is life expectancy. It’s simple: the longer you live, the longer your savings must last.
- Market fluctuations: The economy is rarely ever consistent and retirement years are no exception to this rule. In an economy that’s flourishing, withdrawing more than 4% a year may be perfectly fine. However, at times when the market is uncertain, you may need to spend less, focusing majorly on necessities. Regrettably, there’s no set guiding principle for financial management that wipes your hand clean from hard work. Keeping a close eye on your money and acting accordingly to market fluctuations is essential for remaining afloat during trying times.
- Personal tax rate: Your personal tax rate is affected by several things, such as types of investment, and the size of your accounts. Even the state you live in matters when factoring in other income earned, deductions, and credits.
So, Should You Trust The 4% Rule?
So, is the uncertainty of our financial futures a reason to render the 4% rule completely futile? Well, not exactly. The truth is that the 4% rule is a great rule to start with, only adapting it when necessary, so that it may be in an agreeance with one’s personal life.
And that’s really all there is to it. Like any other financial rule of thumb, the 4% rule should be molded to fit your own personal retirement plan. And as always, it is advised to seek the counsel of a trusted financial planner to help with figuring out what retirement plan will make the most sense for you and your family.