Feature

Is retirement's 4 percent rule out of date?

Time for an update

"What if I told you one of the most common guidelines people use to plan for retirement is wrong?" asked Sean McDonnell at Kiplinger. The 4 percent withdrawal rule of thumb was established more than four decades ago to help retirees "safely avoid running out of money" over a 30-year retirement. Its premise is that you can withdraw 4 percent of your portfolio in your first year of retirement, and then increase the dollar amount each year based on inflation, without risking going broke. But that inflation adjustment is the rule's "biggest flaw." The problem with increasing your yearly withdrawal amounts is that, with the exception of health-care costs, many retirees find their expenses actually decline. Those 65 and older spend an average $14,855 less annually than 55- to 64-year-olds, according to the Bureau of Labor Statistics. And though your early retirement might consist of travel and making your home more comfortable, over time you'll likely "cut back on these big-ticket items for smaller, less expensive ones."

"Whether you start with 4 percent or some other rate," the point is to not be afraid to "adjust your withdrawals" from year to year, said Walter Updegrave at CNN. For one thing, "we don't know how long we'll live. And even if we did, we still don't know how the investment markets will perform." The aim is to achieve a balance between spending down your nest egg too quickly, and being overly cautious, which would mean sacrificing some of the retirement perks you've spent decades working toward. Some advisers suggest setting a 5 percent withdrawal rate in your first year, and then forgoing inflation adjustments following any year in which your portfolio loses value, said Anne Tergesen at The Wall Street Journal. Another method, the "guardrail approach," involves recalculating your withdrawal amount each year as a percent of your new balance. "Any time your withdrawal rate rises above 6 percent, the rule imposes a 10 percent pay cut." So let's say you have a $1 million portfolio and withdraw $50,000 in year one. The next year, after market losses, your portfolio is only worth $800,000; a $50,000 withdrawal plus 2 percent inflation (or $51,000) would be above 6 percent. So you'd take the 10 percent cut, or $5,100, "to produce a $45,900 withdrawal in year two."

Whatever you decide, you should always "stress-test" your plan, said Penelope Wong at Consumer Reports. Continually run your numbers and see how they stack up in the event of a market downturn. Today, the 4 percent rule should merely serve as a "starting point," said Jim Sandager at The Des Moines Register. "Every individual's lifestyle, income, and investing strategy will be different." The longevity of your savings directly affects your quality of life in retirement. So a willingness to be proactive and flexible is more likely to "keep you from running out of money before you run out of breath."

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