At this point, many people recognize the importance of saving money for retirement. It's become clear that Social Security is facing some financial challenges that could result in benefit cuts. And even if that weren't the case, Social Security is only designed to replace about 40% of the average worker's pre-retirement income. Most seniors need roughly twice that much money to live comfortably, and that's where personal savings come in.
Ideally, you'll enter your senior years with a nice sum of money in your IRA or 401(k) plan. But unfortunately, your nest egg isn't guaranteed to last throughout your retirement. Rather, you'll need to be careful about how much money you withdraw to avoid depleting your savings prematurely.
Recent data, however, reveals that many Americans are ill-informed as to what constitutes a safe retirement plan withdrawal rate. And if you're in a similar boat, you could end up in a real financial crunch come retirement.
Go easy on withdrawals
In a recent Fidelity survey, 20% of respondents thought a financial professional would recommend a 10% to 15% withdrawal rate from a retirement plan. But that's way beyond the rate most experts recommend.
For years, financial gurus stood behind the 4% rule, which stated that if you removed 4% of your nest egg's balance your first year of retirement and then adjusted subsequent withdrawals for inflation, your savings would likely last a good 30 years. But even that withdrawal rate may be a bit aggressive.
Back when the 4% rule was established, bonds were paying much more interest than they are today. And since retirees are commonly advised to load up on bonds and shift away from stocks, that impacts what's considered a safe withdrawal rate.
In fact, these days, you may want to stick to a 2.5% or 3% withdrawal rate from your retirement plan if you don't want to risk depleting your savings prematurely. Or, you may decide to go with a 4% withdrawal rate -- and that's not necessarily a poor choice, either.
But should you plan on withdrawing 10% to 15% of your savings on an annual basis? Absolutely not.
If you go that route, you're likely to run out of money very early on in retirement and land in a situation where you're forced to live on Social Security alone. Once that happens, you may need to seriously pare down your lifestyle -- which may not be something you care to do in your 70s, once you're used to a certain standard of living.
Map out a clear strategy
The withdrawal rate that works for some seniors may not be the same rate that works for others. And there are different factors that should dictate what percentage of your savings you remove each year.
If you're entitled to a higher-than-average Social Security benefit, for example, then you may not have to remove as much money from your nest egg. The same holds true if you have income from a property you own or a part-time job.
But either way, don't make the mistake of thinking you can safely remove 10% to 15% of your savings balance each year and expect your nest egg to last. Taking that large a withdrawal for even a single year could lead you down a very dangerous path.