When you retire, how much of your retirement savings can you withdraw each year without running out? One of the general guidelines is the 4 percent rule, but it’s important that you treat it as just that: a guideline.
It’s a helpful starting place, but it could end up setting you back if you stick to it too closely.
Here’s what you need to know about the 4 percent rule:
What does ‘4 percent rule’ mean?
The 4 percent rule refers the amount you plan to withdraw from your retirement account each year.
Under the rule, for every $100,000 in your retirement account you would be able to withdraw $4,000 every year. That has been widely considered a safe amount to withdraw to ensure your money lasts comfortably throughout your retirement.
It’s perceived as sustainable because it allows you to primarily take out interest and dividends from your investments, rather than the bulk of the assets.
The rule is simple, and it’s certainly a good place to start. But there are important factors to consider.
How was the ‘4 percent rule’ calculated?
The 4 percent rule is based on data from 1929 to 1976 — a period encompassing the Great Depression, the worst recession the world has ever seen, and the Great Inflation of the 1970s.
By today’s standards — even taking into account the 2008 financial crisis — 4 percent is an extremely conservative amount.
Sure, you’ll be guaranteed a retirement account that lasts, but you may be denying yourself the comfortable and enjoyable retirement you worked hard for.
This is fine if you want to leave a lot for your family, but you should also make sure you have enough money each year to ensure the retirement of your dreams.
People are living longer – and retiring later
On average, retirees live — and work — longer now than they did.
The 4 percent rule assumes that your retirement account should last you around 30 years, but this doesn’t account for the state of your health at the time you retire or the age at which you retire.
More and more people continue to work past the age of 65, and it’s not uncommon for people to delay retirement until they’re in their 70s.
Your health and when you decide to stop working are highly individual factors, and they call for more specific planning.
Your investment portfolio
The 4 percent rule assumes that your portfolio is more or less evenly divided between stocks and bonds—but for anyone who has most of their money in stocks or most of their money in bonds, the rule might not be useful.
If you’ve invested largely in high-risk, high-return stocks, you’ll be vulnerable to market volatility. But you can expect higher growth relative to returns from bonds if things are going well.
Inflation, taxes and interest rates
Many retirees plan for inflation when they set their yearly withdrawal rate and adjust it accordingly, but it’s important to also adjust for taxes.
Every time you withdraw money from your retirement account, you’ll be required to pay taxes on it, so you might need to withdraw more than the designated 4 percent to live on, depending on your situation.
Furthermore, the information the 4 percent rule is based on might be somewhat outdated: bonds no longer offer the same rate of return, and there’s reason to believe that return will continue to decrease.
The bottom line
The 4 percent rule is still a useful standard to build on, but for the purposes of anyone considering retirement in 2021, it might be too rigid an approach.
While it may not be wise for you to withdraw significantly more than 4 percent a year, your years of retirement warrant a more customized plan. Don’t limit yourself more than necessary.