Is the 4% Rule Messing with Your Retirement Plans?

The 4% investment rule has been around for decades. It might feel comforting to break your retirement numbers down to such a simplistic goal, but the reality is: the 4% rule is nonsense. Why? Everyone's retirement plan is different, and the 4% rule neglects to consider many important factors.

Discover why the highly-touted 4% rule could be sabotaging your retirement plans in this article.

What’s the 4% Rule?

William Bengen developed the 4% rule in 1994. The rule is straightforward: you’re supposed to withdraw 4% of your retirement savings each year, adjusted for inflation. 

Say, for example, you have $2,000,000 saved for retirement. The rule dictates that you should withdraw $80,000 the first year. Then, assuming a 2% rate of inflation, you’ll withdraw $81,600 and follow suit for the rest of your life.

Your Investments May Not be Your Only Source of Income

If you have a pension or plan on taking social security, these can play a significant role in making up your retirement income. Similarly, if you anticipate only partially retiring, it's essential to understand how income from a part-time job could supplement your needs in retirement. Other income sources like rental properties and inheritances may have huge impacts not just on your income but also on the taxes you'll pay.

Since your income will vary, your rate of withdrawal will too. You may choose to take more out of your retirement fund initially so that you can wait a few extra years to reach full-retirement age before taking social security benefits. Then when you begin taking social security benefits, you won't need to withdraw as much. This variability makes a hard-fast withdrawal rate, like the 4% rule, impossible.

You'll Spend Less and Less Over the Years

The 4% rule assumes you'll spend the same amount every year throughout your retirement. In reality, this is never the case — your spending in retirement is dynamic, which is essential to consider.

We often encourage our retirees to spend their money once they hit retirement, within reason, of course! It will get harder and harder to travel and participate in other things you love as you get older. This means your expenses will likely go down over time. You won't have as much money invested to continue growing over time if you spend more of your retirement fund earlier after retiring.

However, you may also need to consider the potential costs of healthcare. For example, will you live in a retirement home, or will a family member take care of you? Do you have any high-risk conditions that could lead to high healthcare costs down the road?

It's essential to plan for the practical needs of retirement so that you can enjoy your post-working years without depriving yourself of funds you may need later in life.

Inflation & Taxes Have Huge Impacts

It's impossible to predict exactly what inflation and taxes will look like once you hit retirement age. However, both have significant impacts on your retirement income. Inflation, for example, can change how much money you'll need to sustain your lifestyle. Meanwhile, taxes can impact how much you'll receive from withdrawals and may influence you to withdraw less to stay within a certain bracket.

What You Can Do Instead

Overall, the 4% rule was made to comfort individuals with little regard to how it applies in the real world. Therefore, you should never use this outdated tactic to build your entire retirement plan.

Get in touch with a financial advisor who's familiar with your unique situation. For example, Anew Advisors specializes in supporting first responders’ and high-income earners’ plans for retirement. Work with your financial advisor to explore all of the options available to you, as well as what you should plan for in the future.

Advisors don't just help you save for your retirement, they also help ensure your income distribution is optimized once you hit retirement age. Reach out to schedule time to discuss your plan with our team of experts.

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