Editor's Note: This story originally appeared on Boldin.
For decades, the 4% retirement withdrawal rule has served as a guiding principle for retirees.
While this rule of thumb has provided simplicity and reassurance, today’s retirees face new economic realities that benefit from a more nuanced and personalized approach.
What Is the 4% Rule?
The rule suggests that if you withdraw 4% of your retirement savings annually, adjusting for inflation, your savings should last through a 30-year retirement.
When the rule was first proposed by financial planner William Bengen in 1994, he analyzed rolling 30-year periods, starting from the 1920s, to determine a safe withdrawal rate that would have survived even the worst market conditions, including the Great Depression and high inflation periods — assuming a diversified portfolio.
The 4% Rule Is a Good Starting Place
“Begin with the end in mind.” — Stephen R. Covey
The 4% rule was conceived as a way to get you to the end goal of fully funding your retirement. And, from that perspective, it is a decent framework.
However, it is just a rule of thumb and should not be considered a full-fledged retirement strategy.
The 4% Rule Has Flaws
The financial landscape has shifted since the 1990s when the 4% rule was developed. While interest rates are higher now, they are still lower than when the rule was developed.
Plus, increasing longevity and unpredictable market conditions strain the sustainability of a 4% withdrawal rate.
For example, a few years of significant market downturn early in retirement, often referred to as sequence of returns risk, can deplete savings more quickly than anticipated.
Additionally, retirees today might live longer than previous generations, potentially requiring their savings to stretch further.
What Is a Good Retirement Withdrawal Rate?
These days financial planning experts suggest aiming for a withdrawal rate of between 3% and 5%.
However, it is much better to understand your personal goals, assess what is right for you, and come up with a personalized retirement withdrawal strategy.
See your retirement withdrawal rate in the Boldin Planner.
A Better Way to Think About Retirement Withdrawals
The 4% rule isn’t ideal for today’s economy. More importantly, it just isn’t the best way to achieve your retirement goals of living a satisfactory life and enjoying lifelong financial security.
Retirement withdrawals should be considered in light of your personal financial situation. You should look at your spending needs (and wants) as well as what sources of retirement income you have as well as other goals for limiting taxes and leaving an estate to heirs.
Let’s explore how to identify a personalized retirement withdrawal rate.
Your Retirement Spending Goals
The most important thing you can do if you want a secure retirement is to visualize the future you want and budget for it. You want to project what all of your spending needs will be for as long as you are in retirement. How you want to spend your money is why you withdraw.
Your projected spending should reflect your essential living expenses, such as housing, health care, and daily necessities, as well as your discretionary spending on activities like travel, hobbies, and entertainment.
Project your spending in meaningful ways:
- Future large one-time expenses (college costs, new cars, travel, etc.)
- How your variable expenses will change over time
- How your housing expense will change over time
- Medical costs
- The possibility of long-term care
And, here are ways to project retirement spending and why it is so important to get this right.
Your Sources of Retirement Income
Retirement withdrawals are unlikely to be your only source of retirement income. You will likely have Social Security benefits, perhaps a pension, and maybe even other investment or passive income sources.
This income offsets your need for withdrawals from savings.
Taxes
Taxes play a significant role in retirement withdrawal strategies, as different types of accounts are taxed differently. Withdrawals from traditional IRAs, 401(k)s, and other tax-deferred accounts are typically subject to income tax, while Roth IRA withdrawals are tax-free if certain conditions are met.
Required minimum distributions (RMDs) from traditional accounts begin at age 73 or later. And failing to take them can result in hefty penalties.
To manage your tax burden, you may want to strategically withdraw more from particular accounts in some years, such as when you’re in a lower tax bracket. And take out less in other years when higher income subjects you to higher brackets.
This can also involve converting some traditional IRA funds to a Roth IRA, a process known as a Roth conversion. While you’ll pay taxes on the conversion amount, it can reduce future RMDs and allow for tax-free withdrawals later.
By carefully timing your withdrawals and considering Roth conversions, you can optimize your tax situation and make your retirement savings last longer.
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