We spend our working years saving for retirement. There comes a point where we will need to turn those savings into an income stream. How much can you take from your savings and not run out of money? Is the 4% rule still valid? Is there a “magic number” we can all use to figure out if we have saved enough?
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The Big Question: How much income can I take and not run out of money?
This is a question we hear over and over from people. Finding the answer creates a lot of stress and anxiety for people. The solution involves many variables, all of which depend on each other. How long will you live? What will you earn on your savings? How much will you spend? The answers to those questions complicate the bigger answer you want to know.
Is the 4% Rule Still Valid?
In 1994, a man by the name of William Bengen completed a major research project. He looked at investment return data and the impact of the temporary downturns on various withdrawal rates. His analysis laid the groundwork for what is known as the 4% rule. This guideline suggests in most investment conditions, you can begin your retirement by taking 4% of your retirement savings as income and be confident of not outliving your savings.
At various times, like the late 1990s, many people tried to push that limit to 6% or even 10%. As long as stocks were generating returns over 20% each year, many people had success. Unfortunately, stocks failed to continue that return trajectory. The people who were taking more than 4% found themselves in a very difficult situation.
Lately, the 4% rule has been questioned by some. And others, including Mr. Bengen, feel retirees can maybe use a slightly higher withdrawal rate. Whether it works or not will depend on what happens in the future. But it is still a good starting point for the conversation.
Let's Look at An Example
This is a 65-year-old, living to age 100. He begins with $500,000. His initial withdrawal rate is $20,000 or 4%. He earns an average of 5.11% per year. His spending increases 2.3% per year for inflation.Starting an income stream at 4% of the initial value, had a success rate of 86%.
What If You Take More?
What happens if you increase the withdrawal rate to 5%, or $25,000? How does this change the probability of success?
If things go well for you, it is possible a 5% (or higher) withdrawal rate will work out in the long run. But you are going to need some good luck to make it happen.
The risk of living a long life...
Planning for your assets to last until you reach age 100 might be overkill. It is not common for people to reach that age. Like future investment returns, one of the biggest unknowns is just how long we need our savings to last. Planning for a longer life helps keep an eye on the risks you face. In the graph above, the yellow line reaches zero at age 86. (It should be mentioned that this is just retirement savings, you would still have Social Security and Pension Income).
The 4% rule still works...as a starting point.
The 4% rule is still valuable to use in basic "back of the envelope" discussions. It's a starting point, not a plan. A plan is an ongoing process with continuous monitoring and adjustments. You may be able to spend more in some years and less in others. Financial conditions and your life continually change, and adapting to what is happening is a key to reducing stress. If you need help with that, we have a team of experienced and highly skilled planners who can help you develop your plan.
Appearing in this Episode...
Todd Kimpel, CLU®, ChFC®
Todd is a financial advisor in Wheeling, WV.
Evan is a financial advisor in Marietta, OH
Neal Watson, CFP®
Neal is a financial advisor in Marietta, OH