The most dangerous thing people can do in making decisions around money is to take advice from a general “rule” that financial advisors offer to the masses. Every person’s situation is different and following any path besides one that is tailored to your specific circumstances and needs lacks prudency.
However, we do appreciate the thought behind some general financial “rules” and welcome using them as a starting point at times as we find the right retirement path forward with our clients. One that we have had clients ask about from time to time is the “4% spending rule.”
The 4% spending rule is a general rule of thumb developed by financial advisor William Bengen that suggests new retirees should withdraw 4% of their retirement savings the first year, then adjust annually thereafter for inflation.
The goal of the rule is to set a rate that can last retirees for roughly 30 years of retirement. You may need to plan on the probability of living much longer than the average life expectancy, which could mean spending 35 or more years in retirement – particularly if you are in excellent health.
There are some assumptions for sustaining this method, such as having a balanced portfolio, and the rule does not consider income sources such as Social Security. Of course, the success of the rule depends on how the market performs and volatile inflation rates could impact the longevity of your retirement savings.
Choosing a prudent spending rate
The 4% rule is generalized for a large population and may not be applicable for all retirees, especially since every person has a unique financial status.
A sustainable spending rate should be built on your time horizon, portfolio allocation and risk tolerance. A prudent approach considers your retirement and legacy goals, circumstances and priorities.
Asset allocation can have a big impact on the portfolio balance and funds available to withdraw.
Here are some questions that you should consider when selecting a spending strategy for retirement:
- What is your time horizon?
- What is your risk tolerance? How will you feel and react during a bear market – will you want to sell investments or remain invested?
- What are you currently saving?
- What additional sources of income will you have in retirement such as Social Security, pensions, annuities, etc., that would reduce your portfolio withdrawal?
- Will your spending be consistent in retirement? Will you spend more or less?
- What are your retirement goals?
- How confident do you want to be that your funds will last?
While the 4% spending rule is well known, it may not be the best way forward for all retirees. Having a trusted financial advisor can help you and your family work through the most financially beneficial way to utilize your retirement savings and other income to help you reach your retirement goals.