The 4% Income Rule – It’s Time for a Change
The common rule of thumb many advisors use, for determining the adequate amount of income to withdraw from your retirement savings, is known as the 4% rule. It simply states that if you withdraw 4% income per year from a diversified portfolio and adjust periodically for inflation, you should have enough income to last your lifetime. This theory claims that market growth should outpace the income withdrawn and also offset periods of market decline to sustain your portfolio. Becoming popular in the early 1990s as a retirement income planning tool, it is still widely used today. This theory, however, could be potentially dangerous for people planning for retirement today.
The 4% rule became popular after William P. Bengen published a paper in October 1994. Until then, the popular theory was 5% withdrawals with a 3% adjustment per year for inflation.
The first problem with the 4% rule has to do with market volatility. The market, over the last 15 years, has experienced periods of great volatility. In 2008, the S&P 500 saw a decline of 50% in a period of just five months. Then it took over six years to recover from those losses. Even many well-diversified portfolios took a huge hit in 2008. Adhering to the 4% rule, a retiree would have to do one of two things: reduce the income received, or maintain the income and risk the plan collapsing. In the early 1990s, the markets hadn’t seen these periods of extreme market volatility.
The second problem is the rising costs of healthcare. Healthcare costs are a growing concern for retirees and outpace the rate of inflation. These increased costs and the potential need for long-term care can devastate most retirement plans.
A better plan would be to use vehicles that can provide optional guaranteed lifetime income in any market conditions. Dividing a portfolio into smart market strategies for accumulation, and into strategies that provide optional guaranteed income, can help increase the chances of a successful retirement plan.
Annuities with an additional income benefit rider can provide guaranteed growth for income and offer guaranteed lifetime withdrawals for a single payee or joint payees. These annuities, in a sense, act as a personal pension plan to supplement social security. One common strategy is to allocate enough to annuities to cover the fixed living expenses social security does not cover. These expenses can include health insurance premiums, taxes, mortgage expenses, and basic living expenses.
These plans can offer optional guaranteed lifetime income, but they are limited in liquidity during the surrender period, which can be up to 10 years in length. Because of this limited liquidity, it is best advised to dedicate a portion of your assets to liquid investments. These liquid investments can then be used to cover any emergency expenses, as well as discretionary income not covered by annuities or social security. This discretionary income is what is used to enjoy retirement, such as vacations, club memberships, and extra spending money.
Finally, you need to have your retirement plan monitored on a regular basis, to adjust any changes that can occur through retirement. A qualified advisor will make these adjustments to the plan to meet any additional needs and to help minimize adverse effects of market volatility.
One of the keys to a happy retirement is to not have to worry about income. A well-diversified portfolio, that is actively managed, can be a major step towards providing added peace of mind and help minimize the worries of running out of income in retirement.
To discover more about you can prepare for retirement with a diversified portfolio, please visit www.feekenfinancial.com.
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