Why new retirees need to reconsider the 4% rule

A popular retirement strategy known as the 4% rule may need some readjustment heading into 2025 based on market conditions, according to a new study.

The 4% rule helps retirees decide how much they can withdraw from their accounts each year and be relatively confident that they won’t run out of money over their 30-year retirement period.

According to this strategy, retirees tap 4% of their nest egg in the first year. For future withdrawals, we will adjust the previous year’s dollar figure upward to account for inflation.

But long-term assumptions in financial markets have lowered that “safe” withdrawal rate from 4% in 2024 to 3.7% in 2025, according to Morningstar research.

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Specifically, expectations for stocks, bonds and cash returns over the next 30 years have declined compared to last year, Morningstar analysts say. This means that if you split your portfolio 50/50 between stocks and bonds, your growth rate will be lower.

History has shown that the 4% rule is a “reasonable starting point,” but it can generally deviate from retirement strategies if retirees want more flexibility with their annual spending, according to Morningstar Personal. said Christine Benz, director of finance and retirement planning. Co-author of new study.

That could mean cutting back on spending in depressed markets, for example, she said.

“We pay attention to the underlying assumptions. [the 4% rule] “People are incredibly conservative,” Benz said, “and the last thing we want to do is scare people or encourage them not to spend money.”

In many ways, extracting the nest egg is more difficult than cultivating it.

Withdrawing too much money too early in retirement generally increases the likelihood that savers will run out of money later in life, especially if markets are down.

There’s also the opposite risk of being too conservative and living well below your income.

The 4% rule is intended to guide retirees to relative safety.

Here’s an example of how it works. An investor withdraws $40,000 from a $1 million portfolio in the first year of retirement. If the cost of living increases by 2% that year, the next year’s withdrawal amount will increase to $40,800. and so on.

Historically, from 1926 to 1993, this formula gave a 90% chance of having money left over a 30-year retirement, according to Morningstar.

Using the 3.7% rule, the first-year withdrawal amount for a hypothetical $1 million portfolio would drop to $37,000.

That said, according to a 2024 Charles Schwab article by Chris Kawashima, Director of Financial Planning, and Rob Williams, Managing Director of Financial Planning, Retirement and Wealth Management, 4% He says the rules framework has some downsides.

For example, they say, taxes and investment fees are not included and apply to “very specific” investment portfolios, i.e. portfolios with a 50/50 ratio of stocks to bonds that do not change over time. I’m writing.

Mr. Kawashima and Mr. Williams also said that they were “firm.”

This rule “assumes that there are no years in which spending exceeds or falls short of the rise in inflation,” they wrote. “This is not how most people spend their retirement. Expenses can change from year to year, and the amount you spend in retirement can change as well.”

Bentz said there are several tweaks and adjustments retirees can make to the 4% rule.

For example, retirees generally spend less in the years following retirement, adjusted for inflation, Benz said. If retirees are comfortable spending less as they enter retirement, Bentz said, that means they can safely spend more early in retirement.

According to Morningstar, this tradeoff would result in a first-year safe withdrawal rate of 4.8% in 2025, much higher than the 3.7% mentioned above.

Long-term care, on the other hand, is a big “wild card” that could increase retirees’ spending in later years, Benz said. For example, Genworth’s latest long-term care cost study found that the typical American was paying about $6,300 a month for a home health aide and about $8,700 a month for a semi-private room in a nursing home in 2023.

Additionally, investors may be able to make small increases if the market has risen significantly during the year, and reduce withdrawals if the market has fallen, Benz said.

Delaying claiming Social Security until age 70, if possible, and increasing monthly payments over the course of a lifetime may be a way to increase financial security for many retirees, she said. . The federal government adds 8% to your benefit payment for every full year you defer claiming Social Security benefits beyond full retirement age until age 70.

However, this calculation depends on where households get the cash to defer their Social Security claiming age. For example, it’s better to continue to live off employment income than to rely heavily on an investment portfolio to cover living expenses until age 70, Benz said.