The 4% Rule is a “Rule of Thumb” used by many people when it comes to retirement planning. Many experts, however, now say it needs an update in 2022. The idea behind the 4% rule is pretty simple, over your first year of retirement, withdraw about 4% of your 401(k) or other defined-contribution plans. In the next year, withdraw another 4%, plus a bit extra to account for inflation. Each year after that, rinse and repeat. But is this rule outdated?
Reasoning Behind It
With today’s turbulent economy, seeing record highs for inflation and plunging stocks, the 4% rule just isn’t as valuable anymore. Retirees that still rely on this rule are faced with 2 very large problems; their portfolio is rapidly losing value, and the yearly inflation adjustment could be excessively big. “It’s not meant to be a retirement plan. It’s meant to be a guideline for a portion of a retirement plan,” said David Lau, DPL’s founder, and CEO. “Too many advisors and too many individuals self-managing their retirement are using this as the retirement plan and saying: ‘This is the safe withdrawal rate. As long as I withdraw 4%, I’m going to be safe.’ That’s oversimplifying things.”
The 4% rule was born in 1994 when a financial advisor proposed it in an article, and in 1998 three finance professors published a paper called “The Trinity Study.” That report came to the same conclusion as in 1994, thus solidifying the rule as the magic number for retirement.
Possible Solutions
Today returns are low and inflation is high. If followed too rigidly, experts say, the 4% rule could be a recipe for rapidly depleting one’s assets. So what’s the solution? Some suggest a simple fix: lowering the percentage. “If your expectation is that you’re going to have to withdraw a lot more next year, and the year after, and the year after that… then you’d better start lower,” Frank O’Connor, the vice president of research at the Insured Retirement Institute said. “The higher inflation is, the lower the initial percentage withdrawal should be.”
Another solution is simply relying less on the numbers yourself and relying on a trusted financial advisor. These professionals are equipped with all the tools and knowledge to be able to point you in the right financial direction.
Wrap Up
Saving for retirement can be a stressful and overwhelming process to think about. That’s why it is recommended to speak with a trusted advisor or financial expert to ensure you are putting yourself in the best position possible when you finally decide to retire and start the next chapter of your life.