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I JUST READ THAT the 4% rule is making a comeback. From where, I thought?
Under the 4% rule, you withdraw 4% of your nest egg in the first year of retirement. If you had $1 million, you’d take 4%, or $40,000. In year two, you’d add inflation to your previous year’s withdrawal. Say inflation ran at 6%. You’d multiply $40,000 by that 6% to get the second-year adjustment of $2,400. Add that to the prior year’s $40,000, and you’d take $42,400. And so it goes on.
Research suggests a retirement kitty could last 30 years using this rule, provided you hold a balanced portfolio of, say, 50% stocks and 50% bonds.
Lately, experts have been tweaking the 4% rule a bit. For instance, the folks at Chicago investment researchers Morningstar have suggested an initial withdrawal rate of 3.3% was more prudent. No matter what the exact percentage, most people need an easy-to-understand withdrawal formula for their retirement assets.
Easy doesn’t mean we should get lulled into complacency, however. Truth is, there are some factors beyond our control. The stock market’s histrionics are one, and another is the inflation rate. In theory, these ups and downs should balance themselves out over a 30-year retirement period—from, say, age 65 to 95.
It’s much harder to stretch savings over longer timespans, such as those who want to retire at age 50 and then have their savings last until age 95. Good luck with that. Believe me, things can get rough enough during the standard 30-year retirement. Look no further than 2022. Stocks fell, bonds fell and inflation jumped.
It’s no time to panic, however. If we invest too conservatively, say by throttling back on stocks, we risk losing the race against inflation. Over enough time, our savings would evaporate.
One answer is to have multiple sources of retirement income, both guaranteed and variable. Most of us have a 401(k) or IRA. That’s variable income. Then there’s Social Security, which is guaranteed—at least for now. That guaranteed Social Security income is the most valuable “asset” most retirees possess, followed by the equity in their home.
Should these be our only assets in retirement? I don’t think so. Some people have a regular taxable brokerage account. That money might be invested in index mutual funds or exchange-traded index funds. Alternatively, income-oriented investors might choose to invest in dividend-paying stocks or a municipal bond fund. Muni income escapes federal tax and usually state income tax as well, provided you live in the state where the bonds were issued.
You don’t need millions of dollars to open multiple accounts. Today, most financial firms have a low or no investment minimum. When you read about saving for retirement, that doesn’t mean all your savings must be kept in qualified retirement vehicles, like a 401(k) or IRA. Instead, mix it up and stay flexible.
For instance, in retirement, if you need more income one year, you could turn off the income reinvestment on one or more of your investments. During times of plunging financial markets, you might take the precaution of setting aside a portion of your required minimum distribution for future use. Alternatively, you could tighten your belt and skip an inflation adjustment for one year. People already have a natural tendency to spend a little less when the market’s down.
The 4% rule may be making a comeback. But it’s just a starting point—and you shouldn’t necessarily follow it precisely.
Balancing your sources of post retirement income is something that many high income earners too often mishandle. If you have access to deferred savings vehicles, especially where company contributions can add to the pot, its tempting to have all of your savings in tax deferred vehicles. Of course, this also means for many, that when they tap these resources, they may also be incurring a tax obligation on every dollar of withdrawal. While saving a certain number of after tax dollar pre-retirement an seem painful, it can make a huge difference in your tax planning post retirement.
I was always told, “Max out your 401 k, you will be in a lower tax bracket when you retire”. Well I did that and guess what? With the RMD, I am in a high tax bracket and the IRMMA hits hard as well. So I would offer young people saving for retirement the advice to work hard to get as much in a Roth account as possible. Be it an employer sponsored 401 k Roth or use a “back door” Roth if your income is high, or both. But the focus should be on Roth accounts!
The Social Security decision is something most people don’t spend enough time thinking about. While more complex strategies have been mostly phased out, it still behooves an individual or couple to think hard about how and when to claim.
As an example of potentially poor planning, a retired couple starts drawing at age 62 at a reduced benefit. Several years later the higher earner passes away. The spouse graduates to the higher monthly benefit but, alas, it is not a great result since the benefit isn’t great having been taken originally at age 62.
A good and timely article. Thank you.
I also found Rob Berger’s video and thinking on how to implement the 4% rule helpful to me in making my decisions.
https://www.youtube.com/watch?v=trNjojtsnJg&ab_channel=RobBerger
Best, Bill
Mr. Quinn, another excellent article! Just a sort of random thought, can anybody please explain why millions of Americans do not invest in the equity markets at all, they are either fearful or uniformed maybe, and they also eschew United States Treasuries, the safest, most liquid investment on the globe, but they will gladly toss so much money to the individual state governments, via lottery tickets, which, depending on the state, will cause you to , almost certainly, lose anywhere from thirty to fifty percent? From my reading, I discovered that because the biggest winnings are taxed so heavily, that is the average return to the ticket buyers. Really? So, avoid long term returns of perhaps mid single digits, net of inflation, for a balanced portfolio, versus guaranteed losses of at least 30 % ?
Good question. My cynical answer is because the majority of Americans go through life with their head in the sand focused on today unaware of what’s going on around them and caring less.
They obsess over immediate problems at the expense of their futures. In short, they don’t pay attention to things important to them and then can’t understand why things go wrong.
As i said cynical, but based on decades of trying to educate thousands of people about retirement, health care benefits and things relating to their financial well being-and often failing.