Saturday , 13 August 2022

Retiring? Don’t Just Go By the 4% Rule – Its Handy But Too General

To help make sure your retirement income covers your needs and lasts for a lifetime, you need a custom plan. The 4% rule of thumb is a handy starting point, but it’s too general. Get specific to find your very own retirement number.

This post by Lorimer Wilson, Managing Editor of munKNEE.com, is an edited ([ ]) and abridged (…) excerpt from an article by Jerry Golden for the sake of clarity and brevity to provide you with a fast and easy read. Please note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

The 4% rule of thumb…looms over the majority of retirement decisions. This is the rule that says people with a reasonable amount of savings when they retire should be able to make that pot of money last for 30 years even as they remove 4% of the total each year for living expenses. Studies have shown that three-quarters of all financial advisers rely on the 4% rule when offering guidance to their clients.

There’s just one problem. Baby Boomers retired last year at the rate of about 8,800 a day, or 3.2 million a year and one size does not fit 3.2 million people. In fact, it is reasonable to think that every one of those retirees will seek a number that is right for them as they customize their retirement income plan to their specific needs. Further, the number is dependent on market conditions and, while the 4% rule…worked historically, it never dealt with the current low interest rates and high stock market valuations at the same time.

No ordinary rule based on averages can replace the factors you need to consider when figuring out how much income your savings can generate. Those factors include:

  • Your age, gender and marital status, all of which impact the life expectancy of your plan.
  • Market returns, interest and dividend rates, and inflation expectations.
  • Your legacy objectives for your kids and grandkids.
  • The amount of retirement savings you have accumulated.
  • Where your savings are invested: rollover IRA versus personal (after-tax) savings or even equity in your home.
  • Your attitude toward taxes, both current and proposed.

To illustrate, the chart below shows the impact of just three variables — age, gender and marital status — on what a viable starting income percentage could be for you using the Income Allocation planning method and typical savings makeup and legacy objectives.

A line graph compares staring income percentage as a function of age and gCourtesy of Jerry Golden

You can see that, unlike the general 4% rule of thumb, a recommended Starting Income Percentage (SIP) can vary from a high of 5.26% to a low of 4.39%, even before we take other factors into account.  Our point is not that it’s higher than the 4% rule, it’s that it’s personalized to the individual. Further, even though it’s more customized, you need to drill down and find out what’s behind the Income Allocation numbers.

Analyzing the SIP and getting the most out of it can make a significant difference in your retirement. For example, if a plan customized for you delivers just 1% more in income per year from your $1 million in savings, that’s $10,000 more to spend in your first year of retirement, or — with 2% annual increase — an additional $337,000 over 25 years.

It’s not enough to select a plan based on whether the number is higher or lower. What you need is a plan that provides you information as an informed investor:

  1. What is my projected income, and what are the sources of that income?
  2. What percentage of my income is safe and not dependent on market returns?
  3. What are my projected savings, how much liquidity do I have, and what’s the legacy?
  4. What are the economic assumptions underlying these projections?

Don’t be put off by the technical-sounding nature of these questions. It’s important that you get a report on your plan, review it yourself or review it with an adviser.  That review can give you confidence — or not — in your number.

Related Articles From the munKNEE Vault:

1. Following “the 4% Rule” In Retirement Is Mostly Unnecessary – Here’s Why

If you’re planning for retirement, it won’t take long before you come across the 4% safe withdrawal rate which goes something like this:

2. Use The 4% Rule To Thrive In Retirement – Here’s How

This post looks at the 4% rule to understand why it works so well in retirement, what could possibly be a stumbling block and how to overcome such a situation should it arise.

3. Don’t Use the 4% and 60-40 Investing Rules of Thumb – They’re Dumb! Here’s Why

One of the things that really frosts me is the financial planning industry that insists on using rules of thumb such as the “set and forget” tools – specifically the 4% and 60-40 rules.

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