Please ensure Javascript is enabled for purposes of website accessibility

Following This Long-Trusted Retirement Rule Could Wreck Your Senior Years

By Maurie Backman - Jun 16, 2021 at 7:06AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Sometimes, rules are meant to be broken.

You're no doubt aware that it's important to save well for retirement, since Social Security will only pay you a limited amount of money each month and you'll generally need income outside of those benefits to maintain a comfortable lifestyle.

But entering retirement with a large pile of cash isn't enough. You'll also need to manage that money wisely, and that's where the 4% rule comes in.

The 4% rule states that if you begin by withdrawing 4% of your nest egg's balance your first year of retirement, and then adjust subsequent distributions for inflation, your savings should last for 30 years. And if you retire in your mid-to-late 60s, that covers you for a period that exceed today's average life expectancy.

Two people in bed with laptop

Image source: Getty Images.

For years, experts have sworn by the 4% rule. But if you follow it blindly, you could end up making your senior years more difficult than necessary.

What's wrong with the 4% rule?

The 4% rule is based on certain assumptions that may not apply to your retirement portfolio. For one thing, it assumes a roughly even mix of stocks and bonds, which you may not have.

If you're the risk-averse type, you may be more heavily invested in bonds by the time you retire, in which case your portfolio is apt to generate less growth. Or, if you're a more aggressive investor, your portfolio might still be heavily loaded with stocks. And in that case, you may be enjoying a higher rate of return on your investments than the 4% rule takes into account.

Furthermore, the rule was established at a time when bond yields were higher. Based on what bonds are paying today, you can't expect the same returns.

What might happen if you follow the 4% rule?

Well, one of two things:

  • You could risk depleting your savings in your lifetime
  • You could withdraw from your savings too conservatively and deny yourself the retirement you've worked hard for

If your portfolio isn't set up to support annual 4% withdrawals (which may be the case if it's very bond-heavy) and you stick to that rate, you could end up running out of money and having to live on Social Security alone.

On the other hand, your portfolio may be set up in a manner that could easily allow for 5% annual withdrawals. If you stick to 4%, it could mean not getting to do some of the things you've always dreamed of.

What's the right solution for you?

It could boil down to using the 4% rule as a starting point, but straying from it.

If you're bond-heavy in your portfolio, you may need to go with an annual withdrawal rate of 2.5% to 3%. If you're stock heavy, you may want to adopt a higher withdrawal rate than 4%.

You can work with a financial planner or play around with different options on your own. The key, however, is to not assume that the 4% rule is right for you, even if it is right for some people.

The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/15/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.