When it comes to retirement income planning, one of the biggest concerns people have is whether their savings will see them through the remainder of their life. To assuage those fears, the 4% rule has been a recommended retirement withdrawal strategy.
What Is the 4 Percent Withdrawal Rule?
A practical rule of thumb to help retirees determine how much money is enough for the rest of their lives, the 4% rule suggests that retirees can withdraw 4% of their savings each year, starting the year they retire and adjusting for inflation for the following 30 years. Created to meet the financial needs of a retiree even during a worst-case economic scenario, the purpose of the rule is to establish a steady income stream that will meet a retiree's current and future financial needs.
Pros and Cons of the 4 Percent Rule
Like any financial guideline, there are advantages and disadvantages to adhering to the rule. Here’s what to consider.
Pro: Reliable Income
The rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976, focusing heavily on the severe market downturns of the 1930s and early 1970s. Because the rule was designed to weather these economic storms, 4% is considered a fairly conservative retirement withdrawal rate.
Con: Lack of Flexibility
The 4% rule is only effective if you adhere to it. Even just one year of splurging on a large purchase — and in turn lowering your account’s principal and affecting your compound interest — can have a big impact on your portfolio’s bottom line.
Pro: Lifelong Income
The 4% rule was created to make your retirement savings last for 30 years or more. Safety and stability are key elements for retirees, and because the rule is so modest in its approach, it’s often touted as a good choice for those who retire at age 65.
Con: Doesn’t Account for Differing Retirement Ages
The 4% rule is focused on preparing for retirement at age 65. If you're hoping to retire early or expect to keep working past age 65, your long-term financial needs will be different. Life expectancy also plays an important role in determining a sustainable retirement withdrawal rate — for some people, 30 years of income might not be enough.
A sustainable withdrawal rate is different for everyone. It’s based on many factors, including the value of your current assets, your expected rate of return, your life expectancy, your risk tolerance, whether you adjust for inflation, how much your expenses are expected to be and whether you want some assets left over for your heirs. While the 4% rule provides an easy rule of thumb for retirees, it’s best to determine a withdrawal rate based on your own unique needs.
Let a Professional Help You
Retirement may be the most complicated financial situation of your life, and you don’t have time for trial and error. Talking to a professional can help you manage your money in the way that works best for you and your situation. Talk to a Farm Bureau financial advisor today.