Is the 4 Percent Retirement Rule Always Right?

If you’re like most retirees, you’ll need some level of income from your savings and investments to fund your lifestyle after you stop working. While you will likely have Social Security income and possibly even a pension, it’s likely that you may also need income from your savings.

The challenge is in determining how much income you should take from your retirement assets on an annual basis. If you take too much, you could deplete your savings and put yourself in a challenging financial situation later in life. Take too little, and you may struggle to cover your living expenses.

A common piece of financial wisdom is to take 4 percent of your savings balance each year as a distribution. The idea behind this recommendation is that 4 percent is an amount that won’t deplete your savings and may even allow you to grow your funds. It’s also a simple formula to use for estimation purposes.

However, this rule isn’t right for everyone. Below are a few reasons why the “4 percent rule” might not be right for you:

 

Market Downturns and Inflation

One of the biggest issues with the 4 percent rule is that it often leads to a static distribution amount. In theory, you would calculate 4 percent of your balance to account for changes in value. If your balance increases, your distribution does, too. The same is true if your value declines.

In practice, though, many retirees fail to recalculate their distribution each year. They set a 4 percent withdrawal rate, and the withdrawal stays flat over several years. The problem with this approach is that it doesn’t account for inflation, which can raise your cost of living over time. You may need to increase your withdrawal amount periodically to keep up with higher costs.

A bigger threat, though, is the failure to consider declines in account value. Few retirees are eager to give themselves a pay cut. If you set a 4 percent withdrawal amount and then don’t change it, you could face a problem if your balances decline. All of a sudden, that withdrawal amount could represent more than 4 percent of your balance. If the downturn persists, you could deplete your assets.

 

Asset Allocation

The 4 percent rule also doesn’t account for your unique asset allocation. If you have an allocation that offers growth potential, then a 4 percent withdrawal could be modest. If you have a risk-free, conservative portfolio with little growth opportunity, however, a 4 percent distribution could be high.

It’s impossible to prescribe an optimal withdrawal rate without knowing how the funds are invested. Your withdrawal amount should be based on your specific needs, goals and objectives, and it should be aligned with your allocation and investment strategy.

 

Unique Spending Needs

Finally, the biggest issue with the 4 percent rule is that it may not be the appropriate withdrawal amount for your objectives. Perhaps you want to enjoy the first several years of retirement and then cut back as you get older. Maybe you want to be frugal in the early years to maintain a nest egg for later. Perhaps you plan on working part time to limit your withdrawals.

There could be any number of factors and criteria that influence your income needs. A better approach may be to build a budget that includes your specific spending goals and your projected retirement income. Then you can determine exactly how much income you should take from your savings each year.

Ready to develop your retirement distribution strategy? Contact us at Spicer Wealth. We can help you analyze your needs and implement a plan. Let’s connect soon and start the conversation.

 

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17378 – 2018/2/13