You’ve prepared for your retirement throughout your life: you’ve maximized your contributions to your retirement accounts, took advantage of the retirement plans your company had to offer and saved money throughout your life to prepare for your retirement period. Once you’ve reached your retirement period, you may feel like you’ve crossed the finish line, and you’re home free.
While reaching retirement is a tremendous accomplishment and should be celebrated, it’s not as easy as simply leaving your job and never having to worry about money ever again. Throughout your retirement period, you will have to budget the amount of money you use, as it is coming from a finite resource. Unlike your salary, you are not receiving steady, predetermined payments from your employer. Instead, you are able to determine how much money you use from your retirement fund year by year.
While this sounds exciting at first, you want to ensure you are being careful with your retirement savings. Remember, this is supposed to last you for the rest of your life – you don’t want to end up running low on funds. You may not be in a position where you can continue to work for the rest of your life and easily make up the difference. Instead, you will need to become a master of budgeting and be strategic about your withdrawals and spending.
What is the Rule of 4%?
The rule of four percent applies to how much money you as a retiree should be taking out from your retirement fund every year. The rule outlines that you should be withdrawing roughly 4% of your remaining investments every year you use them. This general rule of thumb determines an appropriate amount to live on throughout the year, while still ensuring the remaining investments in your account continue to grow and make money of their own.
This rule was introduced in 1994 by a financial advisor named William Bengen. He determined this rule based on analyzing the retirement fund activities of retirees. Bengen found through his research that individuals who took out 4% of their retirement investments every year had enough money to last through 30 years of retirement.
Does it Work?
Because the rule of four percent was established in 1994, it is a little outdated by today’s standards. However, many financial planners still sing its praises as a good starting point when determining how much money you should take out of your retirement fund on a yearly basis. Though this provides you with a good general idea of how much money you should anticipate having year by year in your retirement, there are a few other outstanding circumstances and details you will want to take into heavy consideration as you plan out your retirement future.
To start, your life expectancy plays a significant role in determining how much money you should withdraw on a yearly basis. You never truly know how long you will live, so there is no hard and fast rule as far as using your life expectancy to determine how much money you should use from your retirement fund. That being said, you can still err on the side of caution when it comes to your financial practices.
If you are a considerably healthy individual as you approach retirement, you may want to rethink the four percent rule when it comes to your individual retirement plans. Instead of 4%, you may want to consider using 3%, or even 2% of your allotted retirement funds every year for a little while. As you get older, things may start to change in regards to your health and estimated life expectancy. Frequent doctor appointments and health monitoring can help you determine a realistic timeline for your personal life, and help you decide on an appropriate percentage.
Additionally, the performance of the financial markets can significantly impact your retirement fund amount. Should the markets take a particularly negative turn for a long period of time, your retirement can take a similar downturn. When you are preparing for your retirement, this may not be as big a deal to you – you will have plenty of time to wait out any storms and set up backup plans if needed. However, when you are in your retirement phase, this can register as a larger shock. Understanding the effect the markets may have on your retirement funds, you may want to adjust how much you take out certain years to avoid tremendous loss.
Beyond these details, you will want to consider what you are planning to do during your retirement. If you are planning on working part-time during your retirement, or simply spending time at home and with your family, you may not need as much as 4% of your funds every year. It might be in your best interest to delay your more significant payouts for later on in your life. Alternatively, if you are planning on traveling a lot during your retirement or making some big purchases, like a boat or a new home, you may want to take out a little more than 4% some years to prepare for these investments. Mapping out a tentative plan for your retirement lifestyle will help you decide what’s best for you.
The Bottom Line The four percent rule is a great starting point to determine how much you want to withdraw from your retirement fund year over year. However, just like the rest of your life, your individual circumstances and plans will play a huge role in deciding what’s best for you. Speaking with a financial advisor can help you to determine your best course of action when it comes to managing your retirement funds throughout your life. A strong plan can help you prepare for almost anything that may come your way during this well-earned period of your life.
