I have read a number of articles recently about the 4% Safe Withdrawal Rule and how it might not work in the future as it has in the past. Whether that is true or not remains to be seen. First though, a definition from Investopedia:
“What Is the 4% Rule?”
“The 4% Rule is a practical rule of thumb that may be used by retirees to decide how much they should withdraw from their retirement funds each year.”
The Investopedia article goes on to say-
- The 4% Rule suggests the total amount that a retiree should withdraw from retirement savings each year.
- The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
- The rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976. Some experts suggest 3% is a safer withdrawal rate with current interest rates; others think 5% could be OK.
- Life expectancy plays an important role in determining a sustainable rate.”
Now let me give you some takeaways, from the key takeaways-
- Based on the data from thousands of simulations, 4% is the highest withdrawal rate that can be reliably utilized to ensure retirement assets last more than 30 years.
- The rule takes inflation into account by incrementally increasing withdrawals.
- Taking less than 4% is safer than taking more. Taking more is dangerous in the longer term but can make life more fun in the short run.
The 4% rule seeks to reconcile the fact that there are several moving targets when it comes to retirement planning. The most prominent are that we do not know how long we will live; we cannot be certain how our investments will perform; we have no idea what taxes will be or how robust the economy will remain. Further, we cannot know if there will be unexpected expenses stemming from illness, injuries, business opportunities or reversals, a desire to help our loved ones, and many other factors.
Owing to these considerations, the 4% rule factors in a margin of safety. This is wise but it can put people who are underprepared for retirement in an unhappy place.
If someone has not saved enough for their retirement, they might be tempted to take more than 4% annually. This puts them in a position in which running out of money during their lifetime becomes more likely. Depending on how much more than 4% is withdrawn, running out of money could become a virtual certainty.
Alternatively, they might decide that substantially reducing the lifestyle to which they have become accustomed is necessary. In my view, this is the better response though I might take some getting used to. Think about it, if living with less were so easy, more people would be doing it now!
Let’s see what the 4% rule looks like in real life:
$1 million saved for retirement: $40,000 per year income.
$2 million saved: $80,000 per year income.
$4 million saved: $160,000 per year income.
We need a lot more to retire comfortably AND have peace of mind than most imagine while they are working. If you are on the right trajectory, carry on. If you are doing some math and realize, as most will, that you might be short of your goal, there are a few things you can do to make up the ground.
- Save more.
- Work longer.
- Diversify your retirement vehicles with non-traditional assets.
Saving more is obvious but often overlooked. Why? Because it is usually more fun to spend. Yet saving is the bedrock of financial security and wealth building.
Centuries before there was a stock market, mutual funds, insurance, or annuities - even before there were banks- people saved. Some of them became quite well off by doing so.
For most folks, prudently setting aside a percentage of their income every month is not a get rich quick scheme, it is a get rich slow process. But it is a process with a proven track record.
After almost three decades in my industry, I can tell you the best way to do it. Save first, spend only what is left over. Most people today practice the inverse. They save what is left over after what they have spent. For too many, that means little or nothing.
Further, some individuals fall further behind by purchasing consumer goods on high interest credit cards. This is a huge mistake and should be avoided.
Choose a reasonable percentage of your income, 10% or more if possible, and commit to saving it. Like wearing new clothes it will be a bit uncomfortable at first. After a few months it will be like you have been doing it your whole life.
I often find myself disagreeing with the crowd. Perhaps, it is because I am contrarian by nature. It could also be because what the crowd believes does not always make sense.
Early retirement as a personal goal is a prime example. The idea that we should hurry up and quit doing what we have spent our lives getting good at baffles me. Why? Where are we going? To do what, exactly?
Here again, my experience in helping people improve their financial lives these past few decades have led to insights I hope my clients will benefit from. I have worked with and talked to hundreds of retirees. I often ask them “When you look back over the course of your career, do you have any regrets?”
Without a doubt the two most common regrets they have are “I wish I would have begun saving more, sooner” and “I retired too soon.”
These sentiments reflect two feelings. The first is that they wish they had more money. The second is that they miss work more than they expected. And perhaps one reason for that is while they were working, they had more money!
We tend to look at “old age” as some far-off galaxy in another dimension where the laws of physics and gravity do not exist. We tell ourselves there will be a future time when we can happily accept living with less. Don’t you believe it for a second!
When we are 70, or 80, or 90 or whatever old age is these days, we are still going to want to do fun and interesting things with the people we love. And I will bet you a shiny nickel that none of us will be in any hurry to climb into a hole in the ground.
Tennis great Billie Jean King once said, “pressure is a privilege.” This is because pressure is the handmaiden of great accomplishment.
In a similar way, the ability to work in exchange for compensation is a privilege, especially when you have developed a marketable skill. Do not be in a hurry to retire. You’ll be happy you didn’t!
Assets like permanent (whole life) insurance and some types of annuities can help to fill in retirement savings shortfalls to some extent. The 4% safe withdrawal rule is not the 6% or 8% rule because stock and bond markets can and do fall in value. Sometimes significantly. 4% was the highest number that could withstand those corrections with any consistency.
Annuities and whole life insurance are interesting because they each have their own way of helping to mitigate this problem.
Variable annuities can certainly lose value as their investments are often based on the stock market. However, some annuities have riders that allow investors to lock in their peaks in account value. Therefore, if there is a major decline in the market, the annuity investor can annuitize their account at that higher, locked in amount.
To annuitize means that you give the annuity company whatever is left of your account value in exchange for payments based on that higher amount. Once you have done so, you no longer have call on those dollars. You simply receive payments for a period stipulated in your contract - sort of like a pension.
Whole life insurance, besides all the protections it can provide during a work life, can be a valuable asset for retirement planning. First and foremost, it does not decline in value, which is an ideal characteristic on which to base a retirement plan.
While there is a guaranteed component, the dividends paid to whole life policy holders are not guaranteed. With that said, the top mutual insurance companies have paid them every year for well over a century. Moreover, the cash value in permanent life insurance enjoys tax advantaged growth and distribution.
This can be important for two reasons. First, because the asset does not decline in value one can consider a greater than 4% withdrawal with less chance (but never zero chance) of running out of money prematurely.
Second, if there is a major decline in your 401K, you might consider relying more heavily on distributions from your insurance policy during that time. Accessed properly, these distributions would not be considered taxable income and could allow your 401K assets to rebound when and if market conditions improve, as they have historically.
One important note here is that to purchase whole life insurance one must qualify medically. Therefore, the sooner you avail yourself, the better. Annuities, depending on the type, can usually be purchased by anyone of virtually any age or health.
To sum up, the key to a happy financial life is to save more, work longer, and diversify within and among assets classes. Doing so will provide you with options that others simply will not have. To me, more options are always better than fewer.
If you would like to talk more about designing a financial plan that can work under the broadest spectrum of life outcomes, call Scott McGimpsey at (732) 844-3000. I am here to help.
*With regard to variable annuities, there is a surrender charge imposed generally during the first 5 to 7 years that you own the contract. Withdrawals prior to age 59 ½ may result in a 10% IRS tax penalty, in addition to any ordinary income tax. The guarantee of the annuity is backed by the financial strength of the underlying insurance company. Investment sub-account values will fluctuate with changes in market conditions. An investment in a variable annuity involves investment risk, including possible loss of principal. Variable annuities are designed for long-term investing. The contract, when redeemed, may be worth more or less than the total amount invested. Variable annuities are subject to insurance related charges including mortality and expense charges, administrative fees, and the expenses associated with the underlying sub-accounts. Investors should consider the investment objectives, risks and charges and expenses of the variable annuity carefully before investing. The prospectus contains this and other information about the variable annuity. If you are consdering the purchase of a varibale annuity, please contact Scott McGimpsey at (732) 844-3000 to obtain a prospectus, which should be read carefully before investing or sending money.
Scott R. McGimpsey October, 31st 2023
This material was prepared by Scott McGimpsey and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Neither Cetera Advisor Networks LLC nor Scott McGimpsey is engaged in rendering legal, accounting, or other professional services. If such assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any federal, state, or municipal tax penalty. Moreover, a diversified portfolio does not assure a profit or assure protection against loss in a declining market. UNIFIED PLANNING GROUP is an independent firm.