Deciding how much to withdraw each year from your retirement savings can be difficult. You do not want to run out of money too soon, and you do not want to leave too much money behind that you could have used for a more exciting retirement. Your decision largely depends on how much you have saved for retirement and how long you expect to be retired.
The 4 percent rule for withdrawing retirement money has been a guideline for many years. People have followed it believing it is the right thing to do. After taking a more careful look at the origin of this rule, it may no longer be the best idea for many people.
William Bengen, a researcher, created the rule and proposed it in 1994 in a paper he wrote. He had tried to find the best amount to withdraw when using a 30-year retirement as a standard.
How the 4 Percent Rule Works
Once you start retirement, you withdraw 4 percent of your savings in the first year. In the following years, you could either continue to withdraw 4 percent or make your withdrawals based on the actual rate of inflation for that year.When Mr. Bengen proposed the projected 4 percent withdrawal rate, he assumed that you had 60 percent of your investments in stocks and 40 percent giving you a fixed interest rate, such as bonds. At the time, the interest rates remained rather stable—but this is no longer true.
Potential Problems With the 4 Percent Rule
A potential problem can occur depending on where you withdraw the money from. If you take it from a traditional individual retirement account (IRA) or 401(k), you will owe taxes on your withdrawals. The taxes reduce your usable money, giving you less than 4 percent. While you could increase the amount of your withdrawals, it will affect your remaining balance.Since 1913, the average rate of inflation has been 3.1 percent. In 2022, it hit a high of 9.1 percent, but it was 6.4 percent in January 2023. According to the USinflationCalculator, the inflation rate for August and September 2023 was 3.7 percent.
Longevity Also Determines the Withdrawal Amount
If you waited to make withdrawals until you turned 70 or older, you could withdraw a higher percentage. Forbes suggests that you could increase your withdrawals to 5.4 percent if you are planning on a 20-year retirement. A higher inflation rate means it will take more money to maintain the same standard of living.The opposite happens when you retire earlier and plan on a 50-year retirement. In that case, you may want to lower your withdrawals to 3.3 percent to ensure your money holds out.
Risks That Can Invalidate the 4 Percent Rule
The 4 percent rule should not be considered one that everyone should follow. Your situation may be completely different than someone else’s, which affects your need for more or less money. Several things can affect even the best retirement plans. Prudential provides some of them following:- The Yearly Interest Rate Interest rates on various financial instruments are constantly changing. It affects the balance of your investments and retirement accounts, making it necessary to consider inflation rates before taking withdrawals in the new year.
- The Health Risk The future condition of your health is unpredictable. While you build your financial planning on being healthy through retirement, you have no guarantee. You or your spouse could become terminally ill, which could easily cause a large drain on your retirement savings. USAToday says that retirees (both spouses) will spend an average of $315,000 on medical costs after they turn 65. This figure is for those who have Medicare parts A, B, and D.
- The Longevity Risk Retirement planning for a 20- or 30-year retirement does not mean you will live that long. It simply makes you ready to live that long if you do. Of course, there is still the possibility that you could live to 100 or longer. The better availability of medical care and medicines enables more people to live longer. More women than men will live past 100.
- The Risk of Social Security If you are counting on Social Security to provide a stable amount during retirement, you need to rethink it. The Social Security Administration has warned that it expects to decrease payments by about 20 percent by 2035. If it is part of your 4 percent planning, consider this possible decrease in income unless Congress decides to act on it.
- The Risk of Paying Taxes The 4 percent rule does not consider taxes. How much you will pay in taxes each year has several variables you must consider, such as your income, types of accounts, deductions or credits you can claim, and state taxes. You also must think about how much you will pay for Medicare.
The Portfolio Balance
When he created the 4 percent guideline, Mr. Bengen found that the ideal balance was having 63 percent of your investments in stocks. Less than this amount, he said, would make it hard for the account to manage long periods of inflation.
Tapping into your retirement savings should not be done without watching the market—especially if you depend on investments in stocks and bonds. The 4 percent rule is a suggested guideline, but with the current fluctuations of the economy, make adjustments as needed to ensure a safe withdrawal rate. Be sure to take your required minimum distributions when due to avoid penalties. For the best advice, contact a financial advisor to help ensure you do not run out of money too soon.
The Epoch Times copyright © 2023. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
