Should You Use the 4% Rule for Your Retirement Income? By: Mathew BarberAIF® 2021.01.27

Planning for retirement seems straight forward. You invest a certain amount of money into a particular retirement portfolio for a number of years and watch the nest egg grow.

As you get closer to retiring, the reality of what you have been planning for starts to set in. The idea of just saving a sum of money and riding off into the sunset becomes as novel as the cinematic parody — you need a strategy to make your money last. For some people, the anxiety of determining those specifics can be overwhelming.

That is why the 4% rule is so popular with retirees. It offers an unambiguous withdrawal rate that works for most people, and the concept behind it is simple to implement.

What is the 4% rule?

The 4% rule states that retirees should withdraw an income of no more than 4% of their current investment accounts per year. This approach prevents seniors from running out of money before they pass away.

6 Variables to consider before using the 4% Rule for Retirement

Planning to use the 4% withdrawal rule is easy, but do not assume that it will solve all your retirement income concerns. Consider these future variables that could cause you to alter the plans.

  1. Amount saved

    The 4% rule is an equation that relies on many different factors, including the size of your nest egg. If you were someone who was late to start saving or someone who never saved more than the minimum, then it would be questionable whether the 4% rule works for you.

    A couple able to save $2 million in retirement assets might easily survive off the 4% rule, especially if their home is paid off and they have no major medical bills. However, a 68-year-old with just $50,000 in the bank and a handful of excess expenses will need to reevaluate their options. If someone in this position tried to follow the 4% rule, they would likely need extra income just to make ends meet.

  2. Medical costs and living expenses

    For Many people healthcare expenses are the biggest question when planning for retirement. If you have remained relatively healthy, taken good care of your body and have longevity in your family history, it can be hard to evaluate the cost of physical issues that inevitably crop up with aging. A cold can easily turn into pneumonia, and a simple fall can become an ER visit.

  3. Legacy

    Every investor has different priorities.  Some want to spend down their retirement accounts and enjoy the fruits of their labor through traveling or home improvements or retiring to a warmer climate. Others would rather live frugally and leave the bulk of their estate to family members and charitable organizations.

    If leaving a legacy is a priority to you there are other strategies that can be implemented with the use of estate planning attorneys and charitable organizations.

  4. Inflation

    Inflation is accounted for in the 4% rule, at 2% a year on average. But if inflation increases, then suddenly the withdrawal amount will not necessarily buy as much as it used to. This creates a problem because if seniors withdraw more to have the same purchasing power, they could spend down their nest egg much faster.

    A way that retirees can combat this is with a diversified investment portfolio.  Before making changes to income received or the allocation of retirement portfolios, retirees should consider speaking to a financial planner.

  5. Investment portfolio

    How much you can withdraw greatly depends on your portfolio’s allocations, or how much you own in stocks and bonds. The 4% rule is specifically based on a 60/40 split between stocks and bonds. A portfolio which is more conservative (more bonds and less equities) will historically have a harder time earning enough to support a 4% withdrawal rate, while a more aggressive portfolio will historically earn more than enough but will be more volatile than you may want to experience.  Everyone has a different risk tolerance, so determine yours before choosing a retirement strategy.

  6. Fees
  7. Every investor has power over how much they are paying in investment fees.

    Every portfolio has its own fee schedule that you should be aware of. Some people choose funds that are actively managed because they think they will yield higher returns over passive funds.  When in fact that is generally not the case.  In general, you will pay higher investment fees for actively managed funds and not be rewarded with higher returns.

 Consider hiring a financial planner

A financial planner can look at your entire financial situation (assets, liabilities, projected budget, age, family history, priorities) to determine what withdrawal rate is safe for you. When you work with an experienced advisor, you can get more specific advice tailored to your situation.

As with any plan, your retirement plan and figures change every day.  A financial planner can help you course-correct if necessary but more importantly can help to make you more aware of future roadblocks or obstacles before they happen.

Only Use the 4% Retirement Rule as a Guideline 

When it comes to retirement planning, there are no strict set of rules.  You can use general guidelines as a starting point, but each person has their own set of circumstances that needs to be taken into consideration.

The 4% rule is not gospel, and no one should apply it without looking at all the relevant variables. Even if the 4% rule seems like a perfect fit it my not be the case when you end up taking withdrawals.  As we discussed here, there are clearly variables you could change your circumstances.

If you are close to retirement, hire a financial planner to evaluate your situation. A good planner will recommend seeing them at least once a year during retirement to make sure you do not need to change the withdrawal rate.







Mathew Barber

Mathew is a Senior Consultant at Westminster Consulting, where he is responsible for the firm’s personal advice and employee education programs.

Mathew leads the firm’s participant education and advice initiative, Westminster Workplace Solutions. Additionally, he develops and promotes Westminster...

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