After working hard your entire life to save for retirement, the last thing you want to do is worry about your money running out. And with the right strategy, you may not have to.
For years, experts have been quick to stand behind the 4% rule. It has you withdrawing 4% of your nest egg your first year of retirement and adjusting future withdrawals for inflation. If you follow the 4% rule, there's a good chance your retirement savings will last for 30 years.
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In recent years, though, the 4% rule has come under fire. Rising inflation, longer life expectancies, and a different bond yield environment have some experts declaring that guidance outdated.
The reality, though, is that the 4% rule isn't necessary dead. It may just need a key adjustment.
Flexibility matters
One major problem with the 4% rule is that it's extremely rigid. It has you withdrawing a baseline 4% of your savings and adjusting for inflation regardless of your personal spending needs or what the market is doing. That's where problems can raise.
If the stock market tanks early in retirement and you withdraw 4% of your assets anyway, you're exposed to what's called sequence-of-returns risk. Early losses you lock in could lower your portfolio value permanently, giving you less money to tap going forward and increasing the risk of eventually depleting your IRA or 401(k).
On the flipside, sticking to a 4% withdrawal rate during strong markets could mean underspending. It could also mean having to give up certain goals.
The 4% rule also assumes your spending needs will be pretty consistent throughout retirement. But they may not be.
Early on, you may want to travel and spend a lot of time out of the house. As you get older, you may slow down and prefer less expensive entertainment at home. And then, when you get much older, your overall spending might rise due to health-related needs.
The 4% rule doesn't lend well to these changing needs. And that's why you may want to follow it -- with a tweak.
A smarter way to use the 4% rule
There's no need to abandon the 4% rule completely. But a better idea is to use it as a starting point and adopt some flexibility based on your needs and market conditions.
If there's a major market downturn early in retirement -- or really at any point in retirement -- reducing spending is a smart move that could spell the difference between preserving your portfolio or not. At the same time, if the market is strong early on in retirement and you want to withdraw 5% or 6% of your balance for a couple of years for heavy travel, there's not necessarily anything wrong with that.
You may also decide to land on a starting withdrawal rate in the ballpark of 4% but not quite there. If you have a shorter retirement ahead of you because you worked well into your 70s, a 4.5% or 5% withdrawal rate may be totally appropriate. If you're retiring early, 3% or 3.5% may be safer.
The bottom line is that the 4% rule still has value. But it works best when paired with flexibility. Recognizing that could be your ticket to making your savings last without denying yourself along the way.
