Rising life expectancy means having to pay for a longer retirement. The lack of a pension or frozen benefits translate to fewer, smaller checks from ex-employers. And the days of being able to count on averaging 10 percent annual returns from the stock market are over. All that, makes it even more important for retirees to know just how much they can take out of their portfolios every year without drawing them down too fast.
There isn’t one model that fits all. It depends on individual circumstances, best reviewed with a financial adviser. The classic advice is widely known as the 4 percent rule. If you withdraw no more than 4 percent from your savings the first year of retirement and adjust the amount upward for inflation every year, you can be confident you won’t run out of money during a 30-year retirement.
Before the use of the 4 percent rule became widespread, many people were used to thinking in terms of an average growth rate between six and seven percent on a stock portfolio. Today, while most advisers think the 4 percent rule is valid, we’re in a period of time which may challenge it.
People who retired in 2000 are of the greatest concern. They’re the ones who started and had two major bear markets, which is unprecedented — two big 50 percent drops in the market. A lot of it depends on what happens to stock market returns and inflation over the next five years. The real problem will come about if we get a big boost of inflation (well above its historical average of 3 percent), in that retirees are required to increase their withdrawals. That may make it hard for the 4 percent rule to fly.
For folks retiring today, you probably can’t expect much more than 5 percent a year from U.S. stocks over the next five to seven years. That’s a pretty bad start to your retirement. Bonds also don’t look very good. People retiring today have to be very careful. They may be better off not retiring for a couple of years. The greatest asset you have in an environment like this is a good-paying job, so you’re not dependent on the stock market or the bond market to support you.
Increased life spans are a factor too. If you feel you could live for 40 years in retirement, either because you’re retiring early, or you have an exceptional genetic predisposition, you wouldn’t want to take 4.5 percent, you’d want to take 4.1 or 4.2 percent. If on the other hand you expect a very short retirement — you have bad health — you could think about taking out 6 percent or 7 percent.
For retirees finding their retirement nest egg short of the mark, there are a few other options to consider that might afford some peace of mind. One is to utilize the equity in their home and consider a reverse mortgage. That could take the pressure off their withdrawals. If they can get some money out of their house, they can take less out of their investment portfolio. Another option is to convert a portion of their portfolio to a fixed annuity and get a guaranteed income stream for life.
And the last piece of advice is be conservative in both your living expenses and your investments. Read the entire interview with the inventor of the four percent rule here.