No Retirement Withdrawal Strategy is Perfect, Particularly the 4% One

Saving for retirement is critical and investing those assets efficiently is important.  However, that is not the end of worries for retirement cash flow and security.

When you retire, you have a new problem to be concerned with: how much can you withdraw each year without running out of money.

retirement withdrawal rules
It is not a game, there is no one set of retirement withdrawal rules that can apply to everyone.

The common rule of thumb has been for retirees to withdraw 4% each year — adjusting for inflation as you go along.  This rule is supposed to guarantee 30 years of withdrawals.  So if you have $1,000,000 in savings, you should be able to withdraw $40,000 in your first year.

However, the 4% rule was created for a certain set of retirement and financial assumptions.

Keep reading to learn why you might want to avoid the 4% rule and get ideas for better guidelines to follow.

What is the 4% Rule?

The common interpretation of the 4% rule means a first year withdrawal of 4% of the beginning balance. Thereafter, that amount is increased by last year’s inflation.

Why You Should Avoid the 4% Retirement Withdrawal Strategy

The following is explained by Henry K. “Bud” Hebeler, a former NewRetirement advisor who was an oft published expert on retirement planning.

No mention is made at which beginning age this is appropriate nor what to do when either markets collapse nor an emergency takes a big chunk of savings nor when it becomes obvious that savings will be exhausted with lots more life to go.  (Even though these criteria have a huge impact on your savings.)

On the other hand, some people use a withdrawal equal to 4 percent of each year’s previous balance—every year.  This overcomes the market collapse and emergency draw problems. It also means that savings will last beyond death, but the withdrawals may be very small. The differences between these 4 percent rule interpretations has a huge effect on retirees’ future income and when they may effectively run out of savings.

When savings are in a qualified plan like a 401(k), 403(b), IRS, etc., there are IRS rules for required minimum withdrawals (RMDs) from IRS Publication 590. These are mandatory after age 70 ½ or at earlier ages if inherited. The withdrawal is the end of last year’s balance divided by the Required Minimum Distribution (RMD) factor. See Figure 1.

retirement withdrawal strategies
Required Minimum Distribution Factors

It’s important to consider how the different 4 percent and RMD rules behave in real world situations.

Figure 2 compares those results for a 65 year old who would have retired with $100,000 savings in the difficult period following 1965. It assumes a conservative portfolio with 1% costs, 40% S&P 500 stocks, 50% AAA corporate bonds, and 10% money markets. As you can see, there is no perfect planning method in the real world of varying market prices. Worse may be the surprise events that can take big chunks of savings.

Generally, the RMD calculation will give lower withdrawals than other planning methods. In the few cases where another retirement rule would call for smaller withdrawals, it may still be mandatory to take the RMD withdrawal, but part of it can be reinvested in order not to exceed the preferred smaller withdrawal.

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An Alternative to the 4 Percent Retirement Withdrawal Strategy

Again, explained by Hebeler:

I much prefer to do a completely new analysis each year using a comprehensive planning program that can account for downsizing of a home, life insurance, long-term-care, set-asides for large maintenance projects, and consideration of survivor benefits for early or late deaths.

I have shown that there is a simple way to help smooth out year-to-year changes in withdrawals by marrying a comprehensive analysis with a simple inflation adjustment in an article on The Wall Street Journal’s Market Watch: Just add ¾ of a completely new conservative computation to ¼ of last year’s withdrawal increased by last year’s inflation. Then you can have a much steadier retirement income though it still may fade at older ages.

Recap of Your Options for Withdrawing Money from Your Savings in Retirement

Knowing how much money you can withdraw from your retirement savings each year, without running out of money, is critical for a secure and happy retirement.

However, the amount you can safely withdraw is impacted by a multitude of factors, including: your time horizon (when do you start withdrawing and how long do you need the savings to last) as well as how your assets are invested and how your investments perform.

You have some options for figuring out the problem:

1) Hebeler describes a multitude of withdrawal options in an article on Marketwatch, “There is a Better Way to Plan Retirement Withdrawals.”

2) You can also forget withdrawals and focus instead on retirement income.  You can figure out how much income you need for retirement and make moves to insure that you receive that income for as long as you live — no matter how long that might be.

Focusing on retirement income can be a better approach to managing your money over time.  You can learn more about retirement income in: “3 Steps to a Retirement Income Plan.”

3) No matter your initial strategy, reassess every year.  The NewRetirement Retirement Calculator lets you make these adjustments and you can see the impact of your changes or changes in the financial markets.

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