The 4 percent rule
August 4, 2014
by Brian Wolf

The debate continues: Is 4 percent really a reasonable withdrawal amount to take from retirement assets?

The so-called “4 percent rule” was the idea that retirees can take 4 percent from their savings the first year of retirement, and then that amount plus more each year to account for inflation, without running out of money. Although this seemed like a good idea, it has come under scrutiny by many financial professionals. Many worry that taking that much income on an annual basis will deplete retirement income too soon. Additionally, with health care costs increasing each year, (and Obamacare uncertainties) many worry that clients may not have enough money to be able to cover the expenses, or leave a legacy for their kids.

More doubt comes into play when you factor in stock market fluctuations: the risk of a prolonged market decline during the first few years of your retirement. In other words, timing is everything. If the value of your retirement assets were to decline 25 percent just as you start accessing them, the 4 percent rule may no longer hold, and the danger of running out of money increases. So even if your accounts go back up in five years, retirees using the 4 percent rule might still face an 18 percent failure rate; three times the rate William Bengen, the planner who originated the rule, thought acceptable. If your accounts go back up after 10 years, the failure rate rises to 32 percent, further illustrating the reason many believe sticking with this rule in an uncertain environment is a risky strategy.

With this in mind, many advisors are moving away from a “probability-based” approach of establishing a 4 percent withdrawal rate, and instead are moving toward a “safety-first” approach by taking defensive measures to ensure basic retirement needs are met. If fact, using the safety-first approach, which we refer to as “the insurance company way,” instead of the 4 percent rule, which we call “the Wall Street way,” you can help get guaranteed* lifetime income.

For a few people, the question, How much can I take? is irrelevant. Chances are, if you have a few million dollars in your accounts, you probably won’t really need to worry about the 4 percent rule; that is, unless you really like to spend money. But for most retirees, it’s a cautious struggle to find the balance between what they can comfortably afford to spend in their retirement without running out of money before they run out of life.

This is where a really good advisor can make all the difference in the world. Although no advisor will be able to predict the future, you should make sure that you explore all the possibilities of up and down markets and the risks that you are willing to take in your retirement years, as well as the safety-first options that are available.

Remember, it’s always better to keep what you have than try to get it back.

*Guarantees provided by annuities are subject to the financial strength of the issuing insurance company. Annuities are not FDIC or NCUA/NCUSIF insured.

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