Wouldn’t it be great if there was a nice, simple rule you could follow to know how much money you could safely withdraw from your retirement savings if you want it to last for 30 years or more? Well it just so happens that there is…
It’s called the “4% Rule,” and it doesn’t require much explanation. In retirement, take out no more than 4% of the combined value of the financial assets you own and they’ll last 30 years or more—more than the average length of time Americans spend in retirement.
However, the 4% Rule may be much more valuable as a guide rather that a steadfast rule.
Origins: The Trinity Study
The “rule” originated in a 1998 study by three professors from Trinity University of San Antonio, Texas. They tested five different portfolio asset allocation strategies using historical market index performance for stocks and bonds for the 70-year period from 1926 through 1995, and annual withdrawal rates ranging from 3% to 12%. They found that regardless of the asset allocation – from all stocks to all bonds and several mixes in between – capital remained in the accounts after 30 years if withdrawals didn’t exceed 4% a year.
So, if you’re 65, have a retirement portfolio of $1 million, and don’t want to fun out of money until you’re 95, then you can withdraw up to $40,000 a year.
On Further Reflection…
Right of the bat, a few things seem awkward about the 4% Rule:
- What if you need more than $40,000 a year?
- What do you do if you live to be 100?
- What if you get really spectacular returns in your first few years so that by the time you’re 95, you find you have a much bigger surplus than you expected? You may realize much to your dismay, that all along you could have afforded a more comfortable lifestyle.
- What if in the first few years of your retirement, the stock market drops by 45%?
Questions like these very quickly show the real value of the “rule”: it’s a good place to start. As a starting point, the rule can be especially sobering for people who think they can withdraw 8% to 10% a year for more than 30 years.
Four percent is a good number to use to estimate how much you need to accumulate to retire. For example, if you want $100,000 a year, it’s going to take a nest egg of $2.5 million in today’s dollars.
The Better Way to Optimize Your Withdrawal Rate
The truth is that using the “right” withdrawal rate year after year is a lot more complicated than applying a simple rule of thumb. You need to take into account your health, your family history for longevity, variable rate of return; you risk tolerance, and all of your goals, including what kind of legacy you want to leave.
Ultimately, the only right way to determine how much you need in your retirement nest egg before you retire and how much you can withdraw annually once you’re in retirement is to create a comprehensive financial plan and then update it at least once a year. Please call to discuss this in more detail.
Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.
