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When planning for retirement, many people are looking for simple rules to follow. There are many – one of the most common is the 4% withdrawal rule. It indicates that you can easily withdraw 4% of your savings during your first year of retirement, then adjust this amount based on inflation for each subsequent year, and thus avoid running out of money for at least 30 years.
This sounds good in theory, and it may even work for some in practice. But if you blindly follow this formula, you may run the risk of running out of money prematurely or generating a financial surplus at the end of your life that you could have spent on activities that appeal to you.
Source of the image: Getty Images.
Problems with the 4% rule
Like many of these so-called retirement rules, the 4% rule is about simplicity but is not flexible enough for a wide range of scenarios. This assumes that your investment portfolio contains about 60% equity and 40% bonds, but that your assets can be allocated differently. Investing more in bonds could slow down investment growth as bonds generally do not see equity returns, and when the 4% rule was developed, bond interest rates were much higher than that. 39; aujourd & # 39; hui. If you follow the 4% rule in this scenario, you may retreat too quickly.
Nor does the rule take account of changing market conditions. In times of recession, it is probably not wise to increase your withdrawals. you may want to even reduce them slightly. But when markets are good, you may be able to withdraw more than 4% comfortably.
A third problem is that it does not take into account changes in spending and activity levels in your last years. Most retirees are more active at the beginning of their retirement. They often spend more time on their hobbies or trips, and their expenses are often higher than when they start slowing down and spend more time near their homes.
But the 4% rule is not dynamic enough to take into account these lifestyle changes. This limits you to a predefined amount, which may be too little in your early years and too much in your later years. As a result, you end your life with a lot of money and you have not been able to enjoy your early retirement as much as you want.
How to calculate how much you can spend each year in retirement
There are other retirement strategies that are slightly more dynamic than the 4% rule. The Boston College Center for Retirement Research has proposed a system in which you base your annual retirement withdrawals on the required minimum IRS allocation tables. RMDs are the amounts you have to start withdrawing from all your retirement accounts, except for the Roth IRAs, once you are 70 and a half, unless you are still working and you do not have no more than 5% of the company for which you work. You divide the balance of your account by the distribution period next to your age in this table to determine the amount you have to withdraw each year.
The Center for Retirement Research used this point as a starting point and calculated the annual withdrawal amounts as a percentage of the total balance of your account from age 65 – when it claims to be able to withdraw 3.13% of your retirement savings safely – when you can withdraw 15.67%.
This formula has some of the same flaws as the 4% rule. Changing market conditions can affect what you can safely withdraw, and you are limited to smaller amounts when you are young and may want to spend more. But you can compensate for this by spending the interest and dividends earned in addition to the recommended percentages.
An even better approach is to ignore the strategies of the cookie cutter. Talk to a financial advisor about your retirement plans and how they affect your spending habits. A counselor will help you determine how much you need to save and how much you can spend comfortably each year to avoid running out of money too early.
Be sure to choose a paid financial advisor. Those who earn commissions when you buy certain investments can make recommendations based on their bottom line rather than on your best interest. Always ask for a copy of the advisor fee schedule so that you understand what you are signing up for.
The 4% rule can be a useful starting point for determining how much to spend each year in retirement, but be aware of its limitations. Your needs and goals over the last few years are dynamic and you need a plan to withdraw as well.
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