How To Manage Retirement Withdrawals: The 4% Rule and Other Strategies
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J. David Herman
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Amber Barkley
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The path to successful retirement withdrawals doesn’t have to emphasize the famed 4% rule. But it’s worth considering, experts say.
Coined by financial planner William Bengen back in 1994, the 4% rule suggests that retirees withdraw 4% of their savings in the first year of retirement, then adjust that amount for inflation annually. Bengen found that this approach allows retirees to avoid running out of money for at least 30 years, assuming they have a balanced portfolio of stocks and bonds.
For example, if you retire with $500,000 in savings, your first-year withdrawal would be $20,000. In subsequent years, you would increase this amount based on inflation rates to maintain your purchasing power.
Consider the 4% Rule
It’s an approach that has gained popularity over the years. Financial pros say that while this philosophy can be helpful, there is more to it than that.
“The 4% rule is a general rule of thumb that is best used as a starting point to a more tailored spend down approach,” said Lauren Wybar, senior wealth analyst at Vanguard. “It is most effective to plan your spending around your specific situation — portfolio allocation, income sources and estate planning goals.”
Rob Williams, managing director of financial planning at Charles Schwab, said the 4% rule can come in handy for retirees trying to switch their mindset from saving to spending.
“In practice, it can be challenging to follow,” Williams said. “It’s a reasonable starting point.”
He agreed that 4% is a good approximate starting point, but you should have a personalized plan. “Ultimately, a plan is there to help you make decisions.”
Here are a few other things to consider, as you try to balance enjoying your retirement with making your money last — hopefully — at least as long as you do.
The Bucket Approach
Practitioners of the bucket approach divide their savings into different “buckets” based on when they’ll need the money — often for the short-term, medium-term and long-term. This helps them manage withdrawals more effectively and reduces the impact of market fluctuations.
“The ‘bucket approach’ or ‘multi-goal approach’ allows one to invest according to their specific time horizon,” Wybar said. “The shorter the time horizon, the more conservative the ‘bucket’ of assets should be.”
Williams often advocates for two buckets. The first is for the next two to four years, steady and liquid. The bucket for beyond four years is more focused on growth.
“They can be separate, or they can be part of the same portfolio,” Williams said.
Consider Annuities
Annuities are another option for taking at least some of the guesswork out of retirement withdrawals.
Offered by insurance companies, an annuity is a contract through which you pay a lump sum or series of payments, then in return receive regular payments, either immediately or in the future. The payments can last for a fixed period or for the rest of your life and reduce the risk of outliving your savings.
There are potential cons, however, including high fees, limited liquidity and complex terms.
“There’s no ‘one size fits all’ approach to retirement planning,” Wybar said. “So annuities can make sense for some individuals.”
Handling Economic Turbulence
In uncertain economic times such as these, retirees may wonder whether they should adjust their withdrawal strategy. Experts caution against overreacting, but there are moves to consider — including bumping down that withdrawal percentage and prioritizing essential expenses.
“The red flag has gone up on the race track a little bit,” Williams said. “Let’s see how it clears. Maybe cut back a little bit on your withdrawals, if you can.”
“In times of uncertainty, it’s important to focus on what you can control,” Wybar added. “I recommend only making changes if your current strategy no longer aligns with your overall goals.”
Being Ready for the Unexpected
Unexpected expenses — such as medical bills or home repairs — have disrupted the withdrawal strategies of many retirees. Having an emergency fund separate from your retirement savings can help you weather these surprises without depleting your nest egg.
“The most common pitfall is losing sight of a ‘rainy day’ or emergency fund, as unexpected expenses can really derail the longevity of one’s portfolio,” Wybar said. “We recommend saving $2,000 or half a month’s expenses — whichever is more — in a low risk, high yielding and easily accessible account. Doing so can help you steer clear of high interest credit card debt and safeguard your nest egg.”
Working With a Financial Pro
When in doubt, you may want to consider consulting with a financial expert. Navigating the complexities of retirement withdrawals can be challenging, especially as economic conditions and personal needs evolve.
Working with a financial advisor can provide valuable insights and tailored strategies to help you make the most of your savings.
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