Originally aired June 2024:

The 4% rule is the “golden rule” of retirement planning. Everyone is familiar with it and it’s easy to work out for some quick, back-of-the-napkin math.

Since it is so easy to calculate and implement, many use it as their retirement withdrawal rule. However, this approach may be overly conservative. While using a significantly higher withdrawal rate may go too far, the 4% rule may be too cautious.

Listen in to hear the limitations of sticking with this overly simplistic rule of thumb.

Outline of This Episode

• (2:25) Is the 4% rule too safe?
• (11:16) Does it make sense to spend more in the early years while awaiting full retirement age?

The pitfalls of the 4% rule

Oftentimes, people fail to take into account other income sources when calculating the 4% rule. Social Security and pensions may provide a base income floor which means you could use a higher withdrawal rate from your portfolio.

My biggest problem with the rigid 4% rule is that it isn’t flexible enough. The 4% rule doesn’t allow for spending flexibility and ignores spending adjustments that could be made on actual needs and circumstances.

Another reason to avoid this stringent rule is that it doesn’t fully evaluate outcomes. The probability of success should be viewed as a spectrum. This approach will help measure the total amount of the goal achieved each year providing a more nuanced understanding of retirement readiness.

What to do instead of relying on the 4% rule

Incorporating more realistic metrics, such as goal completion and spending flexibility can lead to higher optimal spending levels. Based on this updated perspective, a 5% withdrawal rate may be more appropriate for the average retiree over a 30-year retirement period.

However, the ideal rate depends on various factors, including the retiree’s specific circumstances and goals.

Recent research introduces guided spending rates, where the withdrawal rate adjusts based on an individual’s flexibility and retirement duration, ranging from 10 to 40 years. Increasing the withdrawal rate from 4% to 5% may seem modest, but it represents a 25% increase in potential income, offering retirees more discretionary funds earlier in retirement when they are more active.

Finding the right withdrawal rate is about balancing safety and practicality. A more dynamic approach that reflects individual circumstances and the ability to adjust spending is essential for effective retirement planning.

In conclusion

The 4% rule is a great rule of thumb based on a worst-case scenario, however, it isn’t comprehensive enough to create a fully-fledged retirement plan.

Your retirement income plan needs to be adjusted based on your spending level, market performance, and inflation. To simply set your income source one day at the beginning of retirement and never look back is a foolhardy endeavor. There is no way that you could accurately plan the next 30 years of your life. Flexibility is key for planning your spending in retirement.

 

Resource Mentioned

• Think Advisor article

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