Many people approaching retirement age have worked within the expectation of the 4%-Per-Year Retirement Rule. Nearly 25 years ago, financial adviser Bill Bengen wrote that withdrawing 4% of one’s “nest egg” per year in retirement would be offset by market returns and ensure financial stability throughout retirement. This “4% Rule” has become a widely held retirement belief ever since.
However, low interest rates and increasingly expensive stocks and bonds have caused some financial advisers to generate new versions of this rule. With many sources seeing retirement as a risky venture in and of itself, these new guidelines are meant to help ensure that no one withdraws so aggressively during early retirement that he/she is left with meager funds in later retirement years. However, the size of one’s retirement savings and budgetary needs each year can affect which, if any, of these rules are applicable to a given case.
Considerations in the Post-2008-Recession Economy
Variable Withdrawals Based on Market Performance: The Wall Street Journal notes that aiming for a 5% withdrawal but taking a “pay cut” in every year where the market performs poorly for the next year’s withdrawal can be a valuable way to weather tough market years without diminishing assets too quickly. Through the formula, any time one’s yearly withdrawal equals more than 6% of the end-of-year balance, given market fluctuation, the pay cut is imposed. On the other hand, a “pay raise” can also be implemented in years when the market makes the withdrawal effectively less than 4%.
The 3% Rule: A simple shift to using only 3% per year makes it easier for even a moderate market to generate returns great enough to maintain one’s nest egg. Aiming savings before retirement toward being able to live comfortably on one’s social security, other income, and 3% of savings ensures more stability. On the flip side, it also represents markedly less available money per year than the 4%-per-year rule.
The Divide-Age-By-20 Rule: Another new rule makes one’s withdrawal amount higher by age: dividing one’s age by 20, USA Today reports, determines the percentage of the withdrawal. While a 65-year-old could withdraw only 3.25%, an 80-year-old could withdraw 4.0%. Although this approach doesn’t strictly account for market volatility, it automatically builds in caution at the outset and greater latitude as one ages.
The Magic Number:Tom Anderson at CNBC chronicles a method that depends on the indices that investment firms use to determine how much it “costs” to have $1 per year in retirement income, scaling up to one’s desired yearly expenses. A magic number calculation is another way to ensure that one’s withdrawals can meet the 4% rule (or whatever target expenses you have). Rather than focusing on a percentage of your nest egg, it focuses on ensuring that, even with conservative anticipated returns, you save toward a high number, one that is likely to yield your target yearly expenses each year without running out in 30 years.
Reducing Stocks May Aid Current Retirees: There is also evidence that rebalancing one’s portfolio to only 20-30% stocks in retirement is likely to generate the predictable, steady growth needed for those entering retirement. This flies in the face of prior wisdom that implied a greater percentage of stocks at early retirement would generate the best growth, despite risk in the stock market.
Varying needs among retirees can strongly impact their strategy when it comes to withdrawing savings on which to live during retirement, even if the overall goal is to live well while being responsible. Regardless of which approach applies best to any personal situation, consulting a qualified financial adviser is an advantageous way to evaluate one’s approach to maintaining appropriate income during retirement.
Chris Bouck has his Series 62, Series 63 and Series 79 securities licenses and has 25 years of experience in strategic and transaction advisory services. As a Principal at SDR Ventures, Chris works closely with clients executing mergers and acquisitions, securing equity and debt financing, and implementing strategic initiatives aimed at maximizing shareholder value.