“…If you’re planning for retirement, it won’t take long before you come across the 4% safe withdrawal rate, which goes something like this: withdraw 4% of your investment portfolio the first year of retirement, and then take that same dollar amount every year, adjusted for inflation…”
Prepared by Lorimer Wilson, editor of munKNEE.com – Your KEY To Making Money!
[Editor’s Note: This version* of the original article by Chris Reining has been edited ([ ]), restructured and abridged (…) by 53% for a FASTER – and easier – read. Please note: This complete paragraph must be included in any re-posting to avoid copyright infringement.]
Here’s how the 4% rule works:
Year 1: Withdraw 4%.
Year 2: Forget you’ve ever heard of the 4% rule and withdraw $40,000 multiplied by the prior years inflation rate. If inflation was 2%, you withdraw $40,800 ($40,000 x 1.02). In year 3, withdraw $40,800 multiplied by the prior years inflation rate, and so on.
The 4% rule only matters for the initial withdrawal, and then it doesn’t matter anymore.
The reason the 4% rule works during recessions is because the 4% rule is based on the worst possible historical scenarios. That’s the whole point.
- Withdrawing that initial 4% incorporates someone who retires on the cusp of some financial nightmare: the depression, dot-com bubble, recent recession…
- The withdrawal rules work because that’s how the rules are designed.
In fact, the vast majority of people won’t face sequence of returns risk. They’ll enjoy decent market returns early in retirement [and] their investments will compound…[In fact, according to] Michael Kitces…following the 4% rule is mostly unnecessary. His research shows that
- if you start retirement with $1 million and use a 4% initial withdrawal, you’re more likely to have $5 million after 30 years than ever dip into principal.
It’s probably okay to use a higher initial withdrawal, but you use the rules because it’s impossible to predict how the future unfolds…
The problem isn’t that planning with these rules doesn’t work. They’ve worked for nearly 50 years. The problem is you can’t predict what will happen. At some point you have to…adapt to the unexpected conditions that life throws at you.”
(*The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.)
Related Articles from the munKNEE Vault:
This post looks at the 4% rule to understand why it works so well in retirement, what could possibly be a stumbling block and how to overcome such a situation should it arise.
One of the things that really frosts me is the financial planning industry that insists on using rules of thumb such as the “set and forget” tools – specifically the 4% and 60-40 rules.
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