MM004: What is the 4% Rule and is it Right for Me?

Have you heard about the 4% Rule and how you can use it to safely make withdrawals from your savings in retirement? It can be a simple rule of thumb to make sure you're able to withdraw enough money to cover your retirement expenses without needing to worry about running out of money before you run out of retirement. That would not be good.

IN THIS WEEK'S EPISODE

* Overview of the 4% Rule

* Figuring out withdrawing for income or expenses

* Talking about LearnVest and when to seek professional guidance

* Challenges to the 4% Rule and why it’s not a good metric

* Why the 4% Rule does provide a good rule of thumb

* Why 4% might actually be a bit too conservative

WHAT IS THE 4% RULE AND IS IT RIGHT FOR ME?

If you're just tuning into The Modest Millions Show, you'll want to catch up on the first few episodes where we cover off on budgeting and some of the principles of the financial independence movement.

Go ahead. Tap pause and go listen to those episodes and then come back. We'll wait.

Alright, welcome back! Like I mentioned at the top, we're going to look at the 4% rule from a couple different angles, so we'll start with a quick overview of the four-percent rule before diving into some of the concerns that some have around this approach and then cover how this rule might benefit you.

I’ve been a fan of the 4% rule for a while, but it wasn’t until I started digging into this topic that I realized how polarizing this topic is. There two very distinct camps, the Fors and the Againsts. There is zero middle ground. The most important thing here, while we review both sides of the debate, is that you might want to consider seeking professional advice to have a professional set of eyes, because your specific situation will definitely dictate whether or not the 4% rule makes sense for you.

So what is the 4% rule?

The "4% Rule" was coined in a 1994 study by financial planner William Bengen. He tested a variety of withdrawal rates against historical rates of return to see how much a person can withdraw over a 30-year retirement without running out of money. It makes sense, right, because in the mid-90s, the average retirement age, was what? 60? 65? a 30-year retirement horizon would take you to 90 or 95 years old, which should have been long enough for your money to outlive you. Bengen found that 4% was the highest rate that held up over a period of at least 30 years. In short, the rule says that you can withdraw 4% of your nest egg in your first year of retirement and then adjust future withdrawals for future inflation. It also assumes that you’re taking moderate risk in your portfolio with 60% in stocks and 40% in bonds. And again, it's designed to last at least 30 years.

Let's put some numbers in to illustrate what this looks like. It's super simple. Rather than working through a convoluted calculation to figure out your number, if your nest egg is $1.75MM, you can safely withdraw 4% of that nest egg every year to cover your expenses, which is $70K per year. Flip the equation around, and if you need $70K per year for your expenses, multiply that annual number by 25 to get the total nest egg that you'll need: $1.75MM.

So why has the 4% rule gotten so much attention?

Most retirement advisors suggest building a nest egg that is based on living on 80% of your pre-retirement income, which depending on the assumptions that they plug into their system and which calculations they use, means they'll suggest you save a nest egg of $2-10MM. That's a really, really big range.

That mirrors some of the variances I've seen when I've used a few different calculators. What are you supposed to do in that scenario?