The 4% rule is a generalized rule that is normally used by retirees to manage their annual withdrawal from their savings.
Bill Bengan, a financial advisor in Southern California, introduced the concept in 1990. According to him, the 4% rule is based on the worst-case scenario. He advised retirees should invest 60% in stocks and 40% in bonds while their withdrawal rate should be 4% in the first year while in upcoming years amount of dollars should be adjusted by the inflation rate. While following the rule you will not run out of money after 30 years of retirement. This rule forces us to consider only portfolio investment and other sources like pension and social security rejected by it. There are a few factors important to consider while using the rule for retirement planning.
- Your source of income
- Your life expectancy
- Your desired portfolio investment
These rules have different pros and cons. I talk about positive things, it’s the simplest rule to follow. It provides you stable income and guards you from going broke. On the other hand, this rule force you to stick with the same lifestyle. It worked best in the poor condition of the market. but it did not guarantee you that you will not run out of money and it can be risky because it did not account for tax.
Retirement and Savings
Savings are the most important factor that provides retirees financial stability. Both factors are directly proportionate to each other. Start saving at an early age like 20 help you to save more and if you own a home and have your own car the possibility of saving could increase till age 65. Statistics show that Americans normally live 20 years after their retirement. So there is a need for a strong retirement plan. Therefore 66% of savings are held by US employees in bank accounts. Fidelity Investments recommends four levels to save as you age.
First level: Save at least one times salary annually at the age of 30.
Second level: Save three times your salary at the age of 40.
Third level: Your annual savings for retirement should be six times greater at age 50.
Fourth Level: Your annual savings for retirement should be eight to ten times greater at age 60.
Other than that you need to analyze your last few month’s spending and maintain the budget to meet the saving limit per month. According to the rule if you have 1 million dollars in savings you can withdraw 4% which is $40,000 and the next year’s inflation rate will need to be considered and the amount will start decreasing. So better retirement planning is very important in saving and sticking with and reviewing it over time.
Safe Withdrawal rate
SWR is a method used by retirees to calculate how much money can be withdrawn annually from savings till the last of their lives.
It is a conservative approach and the rate is calculated based on the retiree’s age of retirement and its portfolio. It guards retirees against recession and worst economic conditions. It allows retirees to withdraw the nominal amounts of savings which normally range between 3% to 4%. While the 4% rule provides a safe withdrawal rate in case of early age retirement. For example, if you planned to travel around your savings could be run out therefore there is a need to figure out withdrawal rate to use savings for longer-term after retirement.
There are many ways to calculate a safe withdrawal rate but the basic formula is given below:
Safe withdrawal rate = annual withdrawal amount ÷total amount saved
Suppose you have $600,000 in saving and you are expected to withdraw $20,000 annually, then your safe withdrawal rate will be.
$20,000 ÷ $600,000 = 0.033 *100 = 3.33%
So it indicates that you can withdraw up to $24,000, which will be about a 4% withdrawal rate. It indicates by following the rate saving will run out between 22 to 25 years while applying inflation rate and other conditions. You can also calculate the safe withdrawal rate here.
There is a drawback of safe withdrawal that it totally depends on retirement time and it varies from person to person. Retirees may lose the joy of their savings to avail better life.
Retirement & Spending
Retirees are no longer bound to spend 40 hours on the job; they are free to have the independence to travel around and spend a bit extra. Retirees spending decreases and are left up to 70% to 80%. Retirees want to live longer with stable income but the cost of living increases annually and with growing age, the healthcare expenses also increase.
Post-retirement luxury lifestyle depends on well retirement planning and spending and saving patterns in early ages. 4% rules give you more surety of 30 years to safeguard your savings. A lower withdrawal rate and wise spending help you to not run out of money.
Professor of Trinity University researched the withdrawal rate of five different portfolios with their withdrawal period ranging from 15 to 25 years and their withdrawal rate also ranges between 3% to 12%. Surprisingly, he found initially low rates guarantee that savings will remain long-term no matter what portfolio mix you have.
Besides, that study showed younger retirees should have initially a low rate to enjoy savings for the longer term while people who retired around 60 to 65 enjoy a high withdrawal rate. Retirees whose rate is 5% their money run out after 15 years and the best portfolio mix is 50% bonds and 50% stocks.
Budgeting will help you to spend your saving wisely. list down all necessary expenses like healthcare expenses, traveling, groceries, clothing, and utilities. Make some slot to spend on entertainment or hobbies to have a healthy life. Avoiding mortgaging and owning a home will cut down your spending. Do consider the profitability from portfolio and market scenario while doing budgeting after retirement.
Following the 4% rule and good retirement planning gives you worry-free life after retirement. So what are you waiting for? Start saving today to enjoy your worry-free retired life.