If you’ve researched retirement planning, you’ve probably seen articles referencing the 4% rule. This mercifully easy-to-follow and understand rule advises that if you draw 4% of your total combined retirement savings annually, with adjustments for inflation, your portfolio will last the duration of a 30-year retirement. But is this rule a bit too simple?
An Example Of The 4% Rule
Let’s say you’ve worked, saved, and invested wisely and now have $1 million in your retirement portfolio. Following the blueprint of the 4% rule, you would withdraw $40,000 in your first year of retirement. In the following year, you would withdraw that amount, but with an increase to account for inflation. For example, if inflation – basically the rise in the cost of living – was 3%, you would increase that $40,000 by 3%, meaning you would withdraw $41,200.
Portfolio Assumptions
The 4% rule assumes that your portfolio is evenly distributed between equities or stocks and fixed-income assets like bonds. But, as you age, you might diversify and change your investment strategy to mitigate risk. Additionally, it’s modeled on historical market returns. If your portfolio underperforms or encounters a down-market, your rate of withdrawal could be too high.
“Withdrawing the same amount each year might not align with your retirement plans.”
Lifestyle Assumptions
While common household expenses might not vary much from year to year, your total spending could. What if you take an extended vacation or buy a new vehicle? These are big-ticket items that you won’t necessarily incur annually, but you’ll need to pull funds to pay for them. Withdrawing the same amount each year might not align with your retirement plans.
Retirement Timeline Assumptions
Without a crystal ball, it’s impossible to know exactly how long your retirement funds need to last. The 4% rule is designed to make your portfolio last 30 years. This extended timeline might not be practical for those who choose to retire later in life. Conversely, younger retirees may opt to reduce their annual rate of withdrawal in order to extend this timeline and avoid outliving their savings.
Building From The Blueprint
While the 4% rule is a solid baseline for preserving your retirement savings, strictly adhering to it might not be practical. It doesn’t really accommodate the ebb and flow of retirement spending and it might over-estimate the performance of your portfolio. Contact an FRC® trained advisor to find a withdrawal strategy that fits your unique retirement goals.
