Is the 4% Rule for Retirement Savings Withdrawals Still Valid?

Building up your retirement savings is only half the battle; once you reach retirement, figuring out how much you can withdraw without running out of money is the other half. It’s a calculation that can be difficult for many retirees to figure out on their own.

To simplify matters, many retirees follow a rule of thumb, the so-called 4% rule. Following this rule would involve withdrawing 4% from your portfolio each year to use as retirement income. For example, if you have a combined $1 million saved across a 401(k) and IRA, you would theoretically withdraw $40,000 each year, adjusting for inflation.

For many retirees, this rule of thumb works well enough to give them some peace of mind about their withdrawal rate, and the retirement income can be enough to support their lifestyles when combined with other income such as from Social Security. Generally speaking, there’s a good chance that withdrawing the same amount each month using the 4% rule will allow retirees to make their nest eggs last 30 years or more.

However, since everyone has their own financial circumstances, a blanket prescription like the 4% rule does not work for all retirees, and you may find that this holds true for you, particularly in the current investment environment.

A Drawback to the 4% Rule

Part of the popularity of the 4% rule is that the relatively low withdrawal rate leaves retirees feeling like they don’t have to worry about running out of money. If your portfolio returns at least 4% annually, you can withdraw your investment gains without losing principal, which can minimize the risk of outliving your nest egg. Yet, in reality, the 4% rule does not always mean that the principal is safe.

In today’s low-interest-rate environment, sustaining 4% in annual portfolio gains can be challenging. Retirees tend to favor low-volatility investments, particularly fixed income, to try to limit the risk of losing what they’ve built up. However, these investments today often return far less than 4%. Even though interest rates have crept back up over the past couple of years, they’re still below historical norms. What’s more, the Federal Reserve signaled in June that rate cuts could be coming shortly.

Over the next 10 years, many investment professionals predict that bonds will return only 2–3% annually, while stocks will also cool down and return 5–6% per year. That means that overall, retirees using the 4% rule may not achieve investment gains that match withdrawal rates. Particularly if their allocation to stocks and bonds sits on the low-volatility side of bonds, gains may be below 4%. And this fact does not account for market drops and therefore potential negative returns.

Plus, when you adjust for inflation, the real value of investment gains may be even lower. As such, you might have to get comfortable with drawing from your investment principal, which would limit the number of years your nest egg lasts.

If this is not palatable to you, you could choose a more flexible approach than the 4% rule, where the withdrawal rate changes based on portfolio performance and income needs. In doing so, you can limit the amount of principal you draw down.

Expect the Unexpected

In addition to the 4% rule’s risk of drawing down principal, its lack of flexibility means that you also risk not having enough income available when large, one-time expenses occur.

For example, under the above scenario where you had $1 million saved in a 401(k) and IRA and were withdrawing $40,000 annually, you would create a budget incorporating $3,333 in monthly income. But what would happen if you needed to make an emergency home repair, had a large medical bill, or experienced anything else that fell outside of your normal monthly spending and was larger than your income coming in?

In all likelihood, you’ll experience unexpected expenses throughout retirement. And if you’re withdrawing the same amount each month and trying to stick to a set monthly budget, you may not have enough to cover those unexpected expenses.

That’s why financial plans should be flexible enough to allow you to comfortably pay for such expenses. If you need to withdraw more some months, you can then re-evaluate your financial strategy to perhaps withdraw less later on or adjust your investments to fit your new financial situation.

Talk It Out

While many retirees appreciate the simplicity of the 4% rule, you may gain more comfort by having a plan that adjusts to your circumstances.

By speaking with a financial planner, you can come up with a more personalized investment strategy and withdrawal rate that fits your risk profile and retirement income needs. For example, if you’re uncomfortable with drawing down your principal, you could work with a financial planner to adjust your withdrawal rate to better match your investment performance.

If you’re trying to figure out the withdrawal rate that works for you based on your retirement savings, reach out to our team at Financial Dynamics for guidance. Our group of financial advisors located in the Richmond, VA area will work with you to come up with a personalized, long-term plan for withdrawing retirement income in a way that gives you comfort.

You can call us anytime at 804-777-9999, or simply text the word “tips” and we’ll make sure we respond to you shortly. You can also listen to our podcast where we discuss the 4% rule and withdrawal rates in more detail.

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