No one wants to be 95 years old and realize that there's no money left to pay for basic needs. Just at the moment when medical bills might start piling up, you need to ask for help from family and friends to make ends meet. Though many would be OK with help from their "tribes," few want to put themselves or their loved ones in that situation, and many won't even have the option.
So, how much money can you pull out of your retirement savings every year and still be able to count on the money being there when you are in your 90s?
For a long time, retirees have been encouraged to follow the "4% Rule": During your first year of retirement, withdraw an amount equal to 4% of your retirement savings, and adjust this number for inflation every year thereafter.
But recently, this 4% figure has come under attack.
- The CEO of Betterment said that with bonds yielding so little right now, a 60/40 stock-to-bond blend won't offer enough return to make the 4% rule work.
- The Wall Street Journal encouraged readers to "Say Goodbye to the 4% Rule" because of uncertainty surrounding stock returns -- specifically if you retired in 2000.
- NBC News claimed that the 4% rule only worked for the wealthy.
Retirement planning: Why the 2000 retirees are probably fine
Well-respected retirement planning guru Michael Kitces has shown that, by and large, the 4% rule is still imminently safe (special thanks to the Madfientist blog for bringing this work to my attention).
In fact, Kitces went back to look at how those who retired in 2000 -- the very same ones that The Wall Street Journal used to question the rule -- are faring today. The results: If they retired in 2000 with $1 million, they would still have about $900,000 left.
However, we need to adjust that number for inflation: $900,000 today is worth about $650,000 in constant 2000 dollars. In other words, about one-third of the nest egg for these retirees has been depleted.
But, as Kitces points out, this assumes these couples truly did adjust their withdrawals for inflation every year. "A growing base of research suggests that retiree spending in real dollars tends to decline in later years," Kitces writes, "which means in practice, a 2000 retiree today is probably even better off and spending even less as a current withdrawal rate than these calculations would suggest."
In other words, while the theory of the 4% rule says these retirees need to tread lightly, the practice says they should be doing just fine.
Some robust numbers to back up the 4% rule
The 4% rule is really meant to be used as a baseline -- the absolute maximum you can take out if you start your retirement at the absolute worst time -- when stock returns are low, and bond yields are, too. It obviously pays to take this safe stance.
But most people don't retire in such dire circumstances. Consider the following, which Kitces also calculated:
- The 4% Rule has a 96% chance -- based on history -- of leaving you with more principal in your account 30 years after you retire. It's important to note that these are nominal, not inflation-adjusted dollars.
- The median retiree, who uses the 4% rule to a tee, will have 2.8 times his/her starting principal after 30 years.
- The maximum safe withdrawal rate over 30 years has sometimes been as high as 10%, with the average sitting at about 6.5%
In the end, the takeaway for retirement planning is clear. Aim for a nest egg that, when 4% of the portfolio is combined with Social Security and any other forms of income, can cover your expenses in year one of retirement. More than likely, your spending won't keep up with inflation. That means your withdrawals will be even safer over time.