As traditional pension plans become as rare as an 8-track collection, more and more Americans are faced with the daunting task of figuring out how much of their hard-earned savings should be withdrawn each year to ensure solvency during their golden years.
The 4% Rule
The 4% Rule refers to the amount that can be safely withdrawn for a lump sum of money to make it last during retirement.
Here’s an example of how it works:
- You start with a lump some of money such as $400,000
- The first year you withdraw 4% or $16,000
- The second year you adjust your withdrawals for inflation. If you use a historical inflation average of 3% your second year income would be $16,480.
- Under this scenario assuming a balanced portfolio of 50% stocks and 50% bonds, your annual income should last you at least 30 years.
What history has shown us
The 4% rule has been a conservative estimate that has stood up during rolling 30-year periods dating back to 1926. Some will argue that the rule is too rigid and doesn’t account enough for variances in market and economic conditions. The 30-year period ending 12/31/2010 showed that an 8% number was achievable (even after the “lost decade” of 2000-2010). While this rule certainly has it flaws, it is important to understand why it is so widely used. The rule serves as an excellent stating point to the retirement income discussion.
Future posts will focus on variations of the 4% rule and how certain unknown variances, such as the sequence of returns, can drastically impact the success or failure of your retirement income plan.