For decades, the 4% retirement withdrawal rule has been a guide for retirees, and while this rule of thumb offered simplicity and comfort, today’s retirees face new financial realities that benefit from a more nuanced, individualized approach.
What is the 4% rule?
According to this rule, if you withdraw 4% of your inflation-adjusted retirement savings each year, your savings should last you through a 30-year retirement.
The rule was first proposed in 1994 by financial planner William Bengen, who analyzed every 30-year period since the 1920s to determine a safe withdrawal rate that, assuming a diversified portfolio, could survive the worst market conditions, including the Great Depression and periods of high inflation.
The 4% rule is a good starting point
Begin with the end in mind– Stephen R. Covey
The 4% rule was designed as a way to achieve the ultimate goal of being fully funded for retirement, and from that perspective, it’s a good framework.
However, this is just a rule of thumb and shouldn’t be considered a full-blown retirement strategy.
The 4% rule is flawed
Financial conditions have changed since the 1990s, when the 4% rule was created. Interest rates, while higher today, remain lower than when the rule was created. Additionally, longer life spans and unpredictable market conditions threaten the sustainability of the 4% withdrawal rate.
For example, a big market downturn early in retirement, also known as cascading returns risk, could deplete your savings sooner than expected. Additionally, today’s retirees are likely to live longer than previous generations, which could mean they need to stretch their savings further.
What is the appropriate retirement withdrawal rate?
Financial planning experts these days suggest aiming for a withdrawal rate of 3 to 5 percent, but you’re much better off understanding your personal goals, determining what’s right for you, and creating a personalized retirement withdrawal strategy.
NEW FEATURE: Check your retirement withdrawal rates in the NewRetirement Planner (part of the Financial Wellness Dashboard).
A better way to think about withdrawing retirement funds
The 4% rule isn’t ideal for today’s economy, and more importantly, it’s not the best way to achieve your retirement goals of living a satisfying life and enjoying financial security for the rest of your life.
Withdrawals from retirement funds should be considered in the context of your personal financial situation — not only your spending needs (and desires) but also your sources of income in retirement and other goals for minimizing taxes and leaving a legacy for your heirs.
Let’s look at how to identify your personalized retirement withdrawal rate.
Retirement spending goals
If you want to retire comfortably, the most important thing is to visualize your desired future and create a budget for it. You need to forecast all the expenses you will need after retirement. How you want to spend your money is the reason for withdrawing it.
Projected expenses should reflect basic necessities such as housing, health care, and household items, as well as discretionary spending on activities such as travel, hobbies, and entertainment.
The NewRetirement Planner helps you forecast your expenses in a meaningful way.
- Record all of your future large one-time expenses (college fees, new car, travel, etc.).
- Consider how your variable expenses change over time. Enter total amounts for different phases of spending (e.g. aggressive spending, slow spending, no spending, etc.) into a basic budgeting tool, or use an advanced budgeting tool to vary your spending in more granular detail.
- Document how your housing costs change over time.
- Get medical cost estimates.
- Consider how you can cover potential long-term care.
- If you have debt, use the NewRetirement Planner to find out when you will be paying off your debt.
Here are nine ways to forecast your retirement expenses and why it’s important to get it right.
Source of income after retirement
Withdrawals from retirement funds are unlikely to be your source of income in retirement. You’ll likely have Social Security, maybe a pension, and possibly other investments and passive income sources.
This income will compensate for the need to withdraw from savings.
The difference between your expenses and income will be the basis of your unique withdrawal strategy
The difference between your retirement expenses and your retirement income is the amount you project you’ll need to withdraw from your savings.
The NewRetirement Planner gives you three options for addressing the gap between your expenses and income: (See My Plan > Money Flow > Withdrawal Strategy.) You can forecast your withdrawals based on the following criteria:
- Your spending needs: This is the default option. The planner calculates withdrawal amounts based on the difference between your income and expenses.
- When considering your gap, it’s helpful to distinguish between spending needs necessary to maintain your standard of living and spending desires that are more flexible and lifestyle-oriented. If you’ve used the detailed budgeting tools in the NewRetirement Planner, you can switch between a “must spend” budget and a “want to spend” budget.
- Fixed percentage withdrawal: If you select a fixed percentage, the system will project the withdrawal of the gap amount and an additional amount up to the percentage you specified for the withdrawal. (However, if the withdrawal to fill the gap is higher than the fixed percentage value, the system will take the higher amount and give priority to the amount you specified for the expenditure.)
- Maximum Spend: If you choose this withdrawal strategy, NewRetirement Planner will take the maximum withdrawal for you while still maintaining the amount you set for your estate goal.
Financial Legacy Goals
If you want to leave some of your savings to your heirs, you will need to exclude this amount from your retirement projections. With the NewRetirement Planner, you can set your financial legacy goals and this money will be excluded from your retirement withdrawals.
tax
Taxes play an important role in your retirement withdrawal strategy because different types of accounts are taxed differently. Withdrawals from traditional IRAs, 401(k)s, and other tax-deferred accounts are generally subject to income taxes, but withdrawals from Roth IRAs are tax-free if you meet certain conditions.
Required minimum distributions (RMDs) from traditional accounts begin at age 73, and not taking them can result in significant penalties. To manage your tax burden, you can strategically withdraw more in years when your tax rate is low and less in other years.
This can involve converting some of your traditional IRA funds to a Roth IRA. This process is called a Roth conversion. You’ll pay tax on the conversion amount, but it can reduce your future RMDs and allow you to withdraw money tax-free later. By carefully timing your withdrawals and considering a Roth conversion, you can optimize your tax situation and extend the life of your retirement savings.
- Use Tax Insights and Roth Conversion Explorer to strategize the best way to withdraw money to minimize taxes.
- You’ll also soon be able to set up custom withdrawal orders to assess tax and estate impacts.
Forget the 4% rule and create a smart, personalized plan with our new Retirement Planner
Developing an effective retirement withdrawal strategy requires a careful balance between meeting your immediate spending needs and achieving your long-term financial goals, a task made easy with the NewRetirement Planner.
By carefully estimating your expected income and expenses, adjusting for taxes, and considering your estate goals, you can create a plan that supports both your current lifestyle and your future goals.
Strategic decisions like varying your withdrawal amounts or taking advantage of Roth conversions can help you manage your tax burden and extend the life of your savings. Regularly reviewing and adjusting your strategy can help you stay on track and ensure a financially stable, fulfilling retirement.
