You save all your working life for retirement, but when the time comes, you'll want to make sure that money lasts. Conventional wisdom says that you should spend only 4 percent of your total savings each year in retirement, but is that still valid? With inflation and changing investment returns, it's important to take a closer look at whether the 4-percent rule still applies.
Defining the 4-Percent Rule
In 1994, financial planner William Bengen showed that by following a certain guideline, retirees could safely enjoy 30 years of reliable income. Called the 4-percent rule, this guideline stated that you should withdraw only 4 percent from savings each year, every year, starting with the first year you retire. So if you had $100,000 in savings and investments on the day you retire, you'd take out $4,000 each year.
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But quite a few things have changed since 1994. A retiree in 1994 was looking at a 75.7-year average life expectancy, compared to the 2020 average life expectancy of 77 years. But market conditions and inflation rates are the biggest contributors to expert opinions advising that we rethink the 4 percent hack, dropping it down to 3.3 percent for modern-day retirees.
Funding Your Retirement
For years, U.S. retirees have been able to rely on Social Security income to fund retirement. The Social Security taxes you pay out of your earnings are set aside to come back to you after you leave the workforce. Some workers also will have funds from a pension to live on.
But it's getting harder than ever to rely on those sources. Social Security funds will be depleted in 2041, according to the Social Security Administration, which means young workers today won't enjoy the same benefits as their parents and grandparents. Unless you're a government worker, it's also unlikely you have an employer-funded pension, although you may get an employer match to your retirement savings.
Retirement Savings Amount Recommendations
Whether it's 3.3 percent, 4 percent or something else, it's important to keep an amount in mind as you're setting money aside for retirement. If you calculate that you can take 4 percent a year out of your savings, at $100,000, that's only $4,000, which is $333 a month. Factor in how much you'll get from Social Security and pensions each month to determine if $333 is enough to supplement that money.
If you've already maxed out any employer match in your company's retirement savings account, research the best way to bump up your investments. Your company's 401(k) puts your funds in before you've paid taxes on it, which means you'll owe taxes when you take the money out later. A Roth IRA, on the other hand, lets you put the money in after you've already paid taxes on it, which means when you withdraw the funds at retirement, you'll enjoy tax-free distributions.
Post-Retirement Market Considerations
It's important, when saving for retirement, to consider how things will look when you retire. The Organization for Economic Co-operation and Development Forecast shows that although inflation has skyrocketed currently, it will begin a downward slide later this year, then level off through 2023.
Still, it's essential to look at what things will likely cost when you do retire, whether it's next year or 30 years down the road. Will you have enough to meet your monthly expenses? Keep in mind that you might have reduced monthly expenses by then, especially if you either plan to pay off your mortgage or downsize to a less expensive home.
Saving for retirement gives you the peace of mind of knowing that someday you'll be able to comfortably leave the workforce, but you want to be sure that the amount you set aside will stretch over those years.
- Annuity.org: The Four Percent Rule
- CDC: Vital Statistics of the United States, 1994
- CDC: Life Expectancy
- Morningstar: https://www.morningstar.com/articles/1066569/whats-a-safe-retirement-spending-rate-for-the-decades-ahead
- SSA.gov: What Young Workers Should Know About Social Security and Saving
- U.S. Bureau of Labor Statistics: 67 Percent of Private Industry Workers Had Access to Retirement Plans in 2020
- OECD.org: Inflation Forecast