People find comfort in rules, especially when it comes to big unknowns, like retirement finances, such as withdrawing 4% annually from retirement accounts. However, withdrawing retirement money takes more than a single rule. Whether your goal is to use retirement savings to spend more time with family and help loved ones while you’re alive or to leave more assets to your heirs, you need more than a single rule.
MarketWatch’s article, “Don’t cheat yourself with the 4% rule,” explains the rule of thumb that says you can withdraw 4% of your portfolio value each year in retirement without incurring a substantial risk of running out of money. With this rule, for every $100,000 you have, you’d withdraw $4,000 a year.
This rule is based on solid academic research, but that research used a “set it and forget it” approach. It didn’t factor in the ability to adjust along the way. Therefore, basing your retirement withdrawals on this rule, is like planning your finances based on your situation at age 25, and then never again adjusting the plan. Experts say that unless we see the return of a Great Depression era, those who use the 4% rule will most likely have a large amount of money left over.
Financial advisors have complex mathematical concepts that can be applied to test your retirement income plan each year, so you feel confident it will continue to work. It can then be adjusted, if necessary. This testing includes things, like a Monte Carlo analysis. It’s a way to simulate random future market conditions, calculating your minimum required return to make your plan work through life expectancy and using present value formulas to compare your scheduled future withdrawals to what you have now.
If a financial advisor wants to use a “set it and forget it” rule to determine retirement withdrawal amounts, consider getting a second opinion for your investment strategy. The world around you changes, from interest rates and market swings to your own family situation. Your retirement strategy needs to be customized and respond to changes around you.
Reference: MarketWatch (June 5, 2018) “Don’t cheat yourself with the 4% rule”