The income you receive from Social Security in retirement probably won't be enough to cover all of your expenses and allow you to lead a comfortable lifestyle. Rather, you'll need outside income to maintain a decent standard of living, and that's where your savings come in.
It's a good idea to start socking money away in an IRA or 401(k) plan from a young age, and then invest that money aggressively so it grows into a substantial sum over time. In fact, if you play your cards right, you might end up with a much higher savings balance than expected.
Case in point: Socking away $500 a month over a 40-year period will leave you with an ending balance of around $1.5 million if your investments generate an average annual 8% return. Since that's a bit below the stock market's average, that's certainly doable.
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But once you retire, you'll need to be careful about taking withdrawals from your retirement plan. You don't want to withdraw money too aggressively because if you do, you'll risk depleting your nest egg in your lifetime. On the other hand, you don't want to withdraw too conservatively, because you might deprive yourself of certain opportunities or make life needlessly stressful.
For years, financial gurus have stood behind the 4% rule, which states that if you begin by removing 4% of your savings balance your first year of retirement and then adjust subsequent withdrawals to account for inflation, your savings should last a good 30 years. But while that rule may have worked well years ago, you may want to take a different approach now.
Why you don't need to stick to the 4% rule
To be clear, there's nothing wrong with using the 4% rule as a starting point in managing your nest egg. But you may want to err on the side of withdrawing from your savings more conservatively for several reasons.
First, when the 4% rule was introduced, bonds were offering much higher yields than they are today. And since your portfolio might largely consist of bonds during retirement (since they're less volatile than stocks and a safer bet for that stage of life), you'll need to adjust for those lower yields by scaling back your withdrawal rate.
Also, Americans are living longer these days than they were years ago. If you're retiring on the early side, you may need your nest egg to last more than three decades. A good way to stretch that money is to stick to a lower withdrawal rate.
That said, if you're retiring later in life -- say, in your mid-70s -- then there's a good chance you won't need your nest egg to last 30 years. In that case, you may be safe to withdraw more than 4% of your savings balance each year.
It's only advice
You may decide that a 4% annual withdrawal rate is a smart one for your retirement. And it's perfectly OK to make that call. But don't stick to that withdrawal rate simply because financial experts have long pushed it.
While the 4% rule may be easy to follow and may have worked well for seniors under different market conditions, it won't be a guarantee that you won't deplete your nest egg prematurely. To be fair, even sticking to a lower withdrawal rate doesn't give you that guarantee. But the point is that a 4% withdrawal rate is one of many options you can play around with, so it's important to consider your own big picture when making that call.
