One huge decision new retirees have to make is how much they will withdraw from their investments. While there is no perfect answer, most advisors would recommend you take a withdrawal of 4% of your starting balance and increase it annually to adjust for inflation. So, is the 4% withdrawal method the best for you?
To figure out if the 4% method is appropriate, you first need to understand the reasoning behind the method. The basic reasoning for taking a 4% withdrawal is because many studies have found that withdrawing 4% of your balance per year is considered a safe withdrawal rate, or put another way – the chances of running out of money are low with a 4% withdrawal rate.
How should you invest to achieve an income of 4%? This is another “it depends” answer; most studies that I have seen involve balanced portfolios, or a portfolio with 60% stocks and 40% bonds to a 50/50 allocation. Notice that the more conservative portfolio still has 50% stocks in it. The reason I point that out is that the income alone produced by the G fund is very unlikely to produce a 4% income.
What will you do in retirement?
Here are a number of questions to consider when looking at your retirement income strategy.
- Do you need or just want extra income from your investments?
- What will you do in retirement?
- Are you willing to adjust your income lower if needed?
- How comfortable are you with market fluctuations?
- Do you want to leave money to your kids or other beneficiaries?
- How old are you?
- How is your health?
- How old is your spouse?
One issue with the 4% rule is that your income remains steady throughout retirement, rising incrementally each year to adjust for inflation. While a steady income may sound good, it isn’t the solution for everyone.
Another issue is that most studies on retirement income are based on math and science, and not human behavior and desires. While I have seen some couples retire and live a very modest lifestyle, I have also encountered others that retire and want to spend money and take vacations that they haven’t been able to previously.
One example is the couple that plans to spend the first years of their retirement traveling. They may need extra income in their first ten years of retirement. Does that mean they can’t travel? Not at all, it just means they have to do a good job of planning. Their travel plans may require taking a 6-10% income for the first five to ten years of retirement.
Yet another issue is that the 4% income rule is pretty conservative, meaning 4% has proven to hold up over almost all 30 year time periods in the market. There have also been many 30 year periods where a portfolio can sustain a 5-6% withdrawal rate.
Withdrawing income above 4% of your investments isn’t taboo, it simply increases your risk of running out of money and the odds that you will eventually have to decrease your retirement income. If you are diligent with your planning, spending extra income in the first few years of retirement is very feasible. It may even be possible to sustain a 5-6% income over a 30 year time period. The key is to have a plan and be flexible when things change!
How long do you expect your retirement to be?
This is pretty simple – the shorter your retirement, the higher your withdrawal rate can be. If you only have an expected retirement of ten years, it should be pretty reasonable to take a withdrawal rate of around 10% per year.
LEO and ATC
The opposite scenario is that of Law Enforcement Officers (LEO) and Air Traffic Controllers (ATC). Many federal employees in these fields can retire by age 50 or even earlier. If you retire at the age of 50, you could easily have a 40 year retirement! In this scenario, a high initial withdrawal rate is a bad idea. If you begin taking an income from your investments at the age of 50, it would be much safer to start at a withdrawal rate of 3-4%.
Retirement income will vary from person to person. The 4% withdrawal rate is a good rule of thumb to go by, but don’t consider it the law. The key is to have a plan before taking withdrawals. If you understand what you are doing and what potential hazards could do to your income, you will be better equipped for retirement. If you would like help with your retirement income strategy, you can email me here.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.