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3 Retirement "Rules of Thumb" That Are Probably Wrong

By Christy Bieber – Updated Sep 21, 2017 at 10:02PM

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Thumbs down on these often-cited retirement rules.

Making decisions on retirement can be overwhelming, but certain "rules of thumb" have become so widely quoted that they're often accepted as gospel. These basic "truths" about retirement may guide your efforts to save for retirement and may impact the ways you use your retirement savings. Since they're so widely repeated and considered conventional wisdom, it must be safe to rely on these basic rules when making important decisions, right?

Unfortunately, like much "common knowledge" often proved wrong as more information becomes available and as circumstances change, some of the most basic and widely accepted rules for retirement may actually be very wrong. And, these "rules" can be wrong in ways that make it difficult to build a big enough nest egg and make it last.

Mature couple looking at financial paperwork.

Image Source: Getty Images.

Here are four of the key retirement rules you should definitely not rely on if you want to be confident that your retirement savings will be there to see you through. 

1. You need to save 10% for retirement

For decades, the 10% rule was touted by financial planners and money managers as an easy way to decide how much income you should save for retirement. The theory is, if you set aside 10% of what you make throughout your career, this money can be invested, grow, and turn into a big pot of cash you can live on when you leave the working world. The reality, however, is quite different. 

If you save 10% of an average salary of around $51,000, you'd set aside around $5,100 each year or $425 monthly. The amount you'd end up with will vary dramatically, depending on the age when you started saving and the performance of your investments. This table shows the likely amount you'd end up with at age 65 under different circumstances, if you invest in a tax-deferred account .  

Age You Begin Investing 5% Return 6% Return 7% Return 8% Return
20 $814,470.00 $1,080,000 $1,460,000 $1,970,000
30 $460,633 $568,317 $705,008 $878,815
40 $243,408 $279,809 $322,570 $372,840
50 $110,050 $118,707 $128,158 $138,475
60 $28,180 $28,748 $29,328 $29,919

The problem quickly becomes clear: Most people don't begin investing when they're 20, many 20-year-olds don't make $51,000 so they can't invest $510 monthly, and many investors don't earn an 8% return.

If you begin investing at 40 and earn just 7%, your retirement savings of $322,570 will allow you to withdrawal no more than $12,900 each year. And that's only if the inflation rate is 3%, you earn a 3% rate of return during retirement, and you live 25 years during retirement.

When combined with the average Social Security benefit for someone who retires at 65, you'd have an annual income of around $26,700 -- well below what you earned while working. Your savings likely won't even be enough even to cover the costs of healthcare as a senior.  If you've started late or your returns are less, you'll need to be much more aggressive in how much you save, since 10% simply won't be enough

2. You can withdraw 4% annually from retirement funds

The 4% rule is another oft-repeated maxim, but this "rule" is designed to determine how much you can withdraw from retirement savings without worrying about spending your investment balance too quickly.  The 4% rule, for example, says if you have saved $322,000, you can withdraw 4% (or $12,880) during your first year of retirement. 

The problem is, this rule is based on a lot of assumptions, some of which may be outdated. The 4% rule dates back to a time when bonds paid higher rates and when people didn't live as long as they do today. In the  80s and 90s, a 10-year government bond could yield more than 8% compared with just over 2% today.  In 1980, life expectancy at birth was 73.7 years. Ten years later, it was 75.4 years. As of 2015, life expectancy was 78.8 years.   

If you earn less in bonds than you did in the past and if you live longer, living by the same old 4% rule could result in you running out of money well before your retirement has come to an end.

3. Seniors shouldn't invest in stocks

Because seniors don't have time to wait for market recoveries, most seniors switch to a conservative investment portfolio. Unfortunately, the problem with being too conservative is that your investment returns may not keep pace with inflation and may not provide you with enough gains to make withdrawals from retirement funds without drawing down your savings too quickly. 

If you invest only in bonds and earn a return of around 2%, a $322,000 investment would produce a return of $7,000 -- which isn't enough to cover even the $12,880 that you'd withdraw from your account under the 4% rule. You would continue to reduce your retirement account balance quickly each year. Worse, inflation -- which is often higher than 2%  -- would eat away at your savings. 

You don't want your entire retirement nest egg invested in stocks, because the risks of a down market are too great. However, it's a good idea to dedicate a portion of your savings to stocks that is equal to at least 100 minus your age. This would mean if you were 70, no less than 30% of your investments would be invested in stocks.  Some financial experts advise investing even more in stocks -- say, subtracting your age from 110 or 120 -- to give yourself more of a cushion over down markets or a longer-than-expected life span. 

By updating your rule book to make sure you're investing enough, investing smartly, and not withdrawing as much as you had previously believed you could, you can make certain you don't run out of money when you're far too old to return to work. 

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