What is the Four Percent Rule and Does it Still Apply?

by Investing School on March 1, 2013

A rule of thumb used to help people determine the amount of funds to withdraw each year from their retirement accounts, the goal of the four percent rule is to allow retirees to enjoy a steady stream of income while leaving enough in their accounts so that the funds continue to grow. The 4% number has long been considered a reasonable rate of withdrawal, since the interest and dividends should be able to keep up with the disbursements.

Retirees who have a longer life expectancy may need to consider other percentages to ensure that they have the funds they need later in life. Medical costs and other age related expenses can increase as the years go by.

Taking into consideration the changes in the economic climate during the last few years, advisors are now recommending that people rethink the 4% figure. For some the figure is not flexible enough. Some suggest that 2% is a better target for a retirement withdrawal rate. Annuities may help solve the financial problems for some retirees.

The advantage of the 4% rule is that it is easy to calculate and helps people anticipate how much they need to have saved for retirement. For example, if a person plans to spend $50,000 per year on top of their expected fixed income sources, they need a portfolio of $1.25 million to support a 30 year retirement. ($50,000/.04). If the total available in the portfolio at the time of retirement is below the needed amount, adjustments to the standard of living will be necessary.

No matter how you view the 4% rule, it is only a guideline. The best way to prepare for your retirement effectively is to start early, save as much as possible and consult with a retirement specialist.

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