It's useful to know that initially withdrawing 4 percent of your retirement savings would allow most people to avoid running out of money through all kinds of historical scenarios. But with bond and stock returns now expected to be lower than historical averages, it's prudent to shine the spotlight on the safe withdrawal rule to make sure retirees are still being conservative by withdrawing 4 percent of assets. Perhaps the safe number is now 3.5 or 2.8 percent. Here are a few other reasons the 4 percent rule might not work for you:
You have an atypical investment allocation. Consider how closely your portfolio and spending patterns resemble the financial scenarios in the 4 percent withdrawal study. If you won't be investing like the portfolios highlighted in the study, the 4 percent rule may not apply to you.
You have set aside a big cash pile. Whether you use the bucket strategy or simply store a big portion of your money in a savings account, you might not want to add that sum into the totals you use for the 4 percent withdrawal rule. That's not to say that having an emergency fund isn't prudent. In fact, a significant stash of cash may even allow you to boost your withdrawal rate from other investments. But having a chunk of your money earning 1 percent or less changes the amount it is safe to spend every year.
Taxes will make a big difference. Many people who do quick 4 percent rule calculations forget to include taxes on withdrawals from retirement accounts, dividends, bond interest and capital gains. Most investors will have to deal with money in both tax-advantaged and taxable accounts, as well as yearly visits with form 1040. Keep this in mind when determining how much you can safely withdraw each year.
Investment expenses will eat into the returns. This will be a bigger problem for people with higher-cost investments than for those who stick with low-cost index funds. High fees erode your investment returns, and the negative impact of the fees accumulates over time to reduce your spending power. If you are paying high fees on your investments, it’s worth the effort to shop around for alternatives.
Making a one-time big purchase that violates the withdrawal rules will cause havoc. The 4 percent rule typically involves setting the initial withdrawal amount at 4 percent and increasing it with inflation every year. Those who cheat and make big purchases (even limiting them to years when your investments perform unusually well) by withdrawing more than 4 percent may be taking too much out to let compounding work in their favor.
You want to withdraw more in the early years and dial it back in the later years. One of the fastest ways to run out of money in retirement is to deplete too much of your portfolio at the beginning of retirement to the point that no bull market will ever help it recover. Unless Social Security, a pension or annuity is going to cover your lifestyle, planning to withdraw much more than 4 percent at the beginning of retirement may cause the balance to dip so low that dialing back later won’t help the balance recover.
A pension or annuity without inflation adjustments makes the math more complicated. You can't just deduct your regular pension and annuity income from your expenses and then calculate a withdrawal percentage because inflation will eat away at the purchasing power. Obviously, having dependable income streams is much better than not having them, but take into account how inflation will impact your fixed income when you are trying to figure out how much is safe to take out.
The 4 percent rule worked through two world wars, the Great
Depression, the hyperinflation years and practically everything in between.
It's really as good of a starting point as any. But do your portfolio and
spending patterns resemble those used in the study that came up with the 4
percent rule? It's worth your time to investigate.