A lot of people work hard to build a retirement nest egg. But then, once their careers actually end, they wind up disappointed when they realize they're able to withdraw only a limited amount of money from their IRA or 401(k) each year.
Financial experts tend to promote the 4% rule for managing a retirement nest egg. The rule states that if you withdraw 4% of your IRA or 401(k) account balance your first year of retirement and adjust future withdrawals for inflation, your savings should last 40 years.
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That rule makes sense at face value. The problem is that it may not lead to the annual income you want.
If you start off retirement with a $1 million IRA, which is arguably a lot of money, the 4% rule gives you only $40,000 a year. And while there's probably some money from Social Security coming your way on top of that, it may still not amount to the annual retirement income you're hoping for.
The good news is that you may be able to get more income out of your savings than what the 4% rule allows for. But to pull off larger withdrawals, you're going to have to take some risks.
A portfolio with higher returns gives you more leeway
The 4% rule was derived with the assumption that the typical retirement saver would maintain a fairly equal mix of stocks and bonds in their portfolio. If you want more annual income out of your savings, the answer is simple -- take on more risk. Go heavier on stocks in your portfolio so your investments are able to generate higher returns.
If you have a retirement portfolio that's 70% stocks and 30% bonds, you may be able to sustain a 5% withdrawal rate without the risk of running out of money. If you have 80% of your portfolio in stocks and 20% in bonds, you may be comfortable withdrawing 6% of your balance each year or more.
You need a backup plan if you're going to increase your risk profile
Of course, this strategy isn't without risk. It's one thing to have 70% or 80% of your portfolio in stocks while you're working and retirement is many years away. It's far riskier to have that large a percentage of your assets in the stock market when you're actively taking retirement plan withdrawals.
This strategy could still work, though, if you have a backup plan in the form of generous cash reserves. If you keep enough cash on hand at all times to cover two to three years of living costs, then you're helping to mitigate the risk of having most of your investments in stocks.
Say the stock market tanks during your retirement, and it takes two full years for it to recover. If you have three years of cash available, you can leave your portfolio alone to ride out that downturn without locking in losses. That allows you to take larger withdrawals during periods when the market is going strong.
Of course, your approach to maintaining a retirement portfolio will ultimately have to boil down to your personal risk tolerance. But if you find a 4% withdrawal rate too limiting, know that you do have other options. It's just a matter of whether you want to exercise them.
