Ever heard of the "4 percent withdrawal rule"? For years, this "common wisdom" has served as rule of thumb for retirees, guiding them on the amount they can safely withdraw from their savings each year in order to fund a 30-year retirement.But is this rule really the standard that all retirees should follow? Not all retirement plan advisors agree that the 4 percent withdrawal rule applies universally. Some retirement investment advisors believe it's too low - others suggest that it's too high - still others suggest it should be evaluated every year. Either way, this long-standing rule can be utilized as a starting point from which retirees can decide exactly how much withdrawal works best for their unique financial situation.
How Does the 4% Withdrawal Rule Fit Your Financial Planning Process?
The 4 percent rule originated in 1994, when investment professional Bill Bergen (with a bit of help from his computer) needed an answer to give the many retirees who asked him how much they could safely withdraw each year. Bergen came up with the 4 percent rule based on his findings that retirees who withdrew 4 percent from their portfolio balance each year, each time adjusting for inflation, would increase the odds of creating a source of income that would allow them to have a comfortable retirement over a 30-year period.The rule stood for many years, but in an era of historically low interest rates, many wealth advisors have begun describing the 4 percent rule as simply a starting point when planning retirement strategies, rather than a rule of thumb. Given that every retiree has a unique financial situation, it makes sense to view the 4 percent rule as a guide, with the assumption that course corrections will be necessary over time. Health issues, unexpected expenses, rising cost of living, and many other unpredictable events may necessitate shifts away from that 4 percent annual withdrawal rate.
How Do Retirement Investment Advisors Suggest Making the 4% Rule Work for You?
There are several important variables that may affect your retirement planning when it comes to the 4 percent rule, retirement plan advisors say. The following adjustments may help meet your financial needs.
Maintain a diversified portfolio throughout your retirement. Once you start taking withdrawals, you still want your assets to grow; resist the urge to convert your savings to CDs and bonds, and keep some of your assets in stocks. A truly diversified portfolio that generates returns of six percent can still work with the 4 percent rule, allowing you to see portfolio growth at a modest rate. Start the conversation with your advisor at a 50-50 or a 60-40 split between stocks and bonds.
Portfolio diversification includes international stocks. A truly diversified portfolio incorporates international stocks. A globally diversified portfolio offers you protection during market volatility and may support a higher withdrawal rate.
Don't overspend when times are good. Though it's hard to not to splurge a bit during those years when the market is bullish, resist the urge. Even if your returns are significantly higher, maintain discipline and stick to your withdrawal plan. You'll thank yourself later.
Don't react emotionally when times are not so good. On the flip side, when returns aren't as stellar, it's still important to stay the course. Setting aside enough funds to cover your cost of living for one and a half to two years, and keeping some assets in lower risk buckets like CDs or short term high-quality bonds, can help you make it through bear markets. Above all, don't react emotionally; stick to your long-term plan.
Consider additional income sources. Retirement comes along with many unknowns, such the rising cost of healthcare. Adding alternative income streams, such as long-term care insurance and Medicare supplements, may help ease your mind. Remember, your retirement plan advisor is here to help you navigate your retirement planning process, whether you choose to follow the 4 percent rule or not.