Everyone’s retirement is different, but we all have a common goal: ensuring our retirement savings last long enough.
The 4% rule is arguably the go-to guideline for determining how quickly you can spend your savings. It states that a retiree can withdraw 4% of their nest egg’s initial value annually, adjusted for inflation. In other words, someone who retires with $1 million would withdraw $40,000 annually, increasing it slightly every year to adjust for inflation.
It’s a good starting point for developing some basic frameworks but is hardly a retirement plan. The problem with painting with broad strokes is that you’ll never fill in the finer details.
There are some considerations when applying the 4% rule and some essential tips to ensure you have the right plan for your needs. Here is what you need to know.
The 4% rule has some issues
I’m not picking on the 4% rule, but people shouldn’t use it to plan their retirement finances. It’s a guideline, not an A-to-Z plan. Here are some potential problems with the 4% rule:
It doesn’t account for market volatility
One of the biggest problems with the 4% rule is it doesn’t account for the market volatility your nest egg could face. The stock market has historically averaged annual returns between 8% and 10%, but those year-to-year swings could be up or down 20% to 30% in any given year.
Suppose something happens and your nest egg takes a big hit the year you retire or shortly afterward; mathematically, you’ll deplete your savings faster. Luck plays a role in investing, which the 4% rule doesn’t account for very well.
Some living expenses could inflate faster
Shelter and healthcare are big-ticket living expenses for most retirees. Both have soared since the pandemic and projecting what those costs may look like years later in life is challenging.
Unfortunately, America’s soaring debt levels mean that future retirees, especially those with decades before retirement, shouldn’t assume that welfare programs like Medicare will cover as much as they do today. Whether healthcare, food, transportation, or housing, essential living expenses could realistically outrun the 4% rule.
It’s not specific to you
Lastly, the 4% is a general guide, not tailored to your financial situation. The typical U.S. worker retires between 63 and 65 with a median nest egg of $200,000. You might have more or less saved or retire earlier or later than the average.
You can get away with sloppy planning early in retirement but could face big problems if your savings dry up years later when you’re too old to work anymore. Additionally, you don’t want to scrimp and save your whole life only to leave a ton of money on the table because you lived too conservatively.
Consider these potential changes
The 4% rule gives you a basic idea of your lifestyle in retirement, but you shouldn’t stop there. Consider these additional tips to help you live your best retirement possible.
Evaluate your timeline
The 4% rule aims to stretch savings for at least 30 years. However, the math may not add up. The average life expectancy in the U.S. is 77 years. In other words, the average person lives roughly 12 to 14 years after retirement. The 4% rule could be too conservative unless you’re retiring early. Consider building a retirement plan with multiple time frames in mind. You want to know your savings will last without overly restricting your lifestyle to the point it hurts your quality of life.
Revisit your investment strategy
Many people retire with less than they had hoped. However, your savings doesn’t stop growing once you retire. You may be able to help your portfolio grow through retirement by adjusting your investment strategy. The 4% rule assumes a portfolio that’s 60% stocks and 40% bonds. You should never take more risk than you’re comfortable with, but getting a little more aggressive could make a big difference in your retirement portfolio over the 10-plus years after you stop working.
Consider dynamic spending
Lastly, the 4% rule assumes you’ll withdraw roughly the same amount each year from your savings. As mentioned before, a market downturn could disrupt your retirement plans. If your finances allow it, consider a dynamic system where you withdraw lower amounts when the market declines and higher amounts when it is up. That could mean some simple lifestyle choices, like saving that big vacation for when the market has a good year or stretching that old car a little longer. These small changes could stretch your nest egg years longer.
Have questions? Consult the pros
Retirement planning is a complex topic. If you have questions or feel overwhelmed by the process, don’t hesitate to consult with a professional advisor. While it will cost you some money to get professional advice, the benefits of an effective retirement plan will far outweigh them.
Retirement planning is the financial foundation for a good chunk of your life. Skimping on preparation or taking retirement lightly only hurts you and can cost you thousands of dollars in taxes and opportunity costs. Knock your retirement plan out of the park by going beyond the 4% rule.
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Forget the 4% Rule? Here’s What You Should Really Be Looking at During Retirement. was originally published by The Motley Fool
