Why the 4 Percent Rule No Longer Works
For decades Americans have calculated their retirement saving needs on the 4% Rule-- if you can withdraw 4% of your retirement fund per year, there’s every chance you’ll have enough money for your golden years. That rule was calculated on interest rates much higher than we’re seeing now, and it’s proving to be not so reliable for people who will retire in the future. According to recent research from PwC, this rule should be viewed as a conservative yardstick.
Another factor is that the rule was based on a 25-year retirement, and as life expectancy increases, so too does the length of retirement. The research also shows that spending patterns are not constant throughout retirement – there are typically higher expenses at the beginning and at the end of retirement, so during those times, the 4% will probably not be sufficient.
When you first retire, it’s tempting to indulge in the activities you’ve looked forward to like traveling, visiting family, or taking up a hobby. In the later phase, it can be healthcare or assisted living fees that eat into your fund. It would be wise to keep a rein on spending in these phases, and ensure that you’re able to withstand any unforeseen financial shocks.
Another study published in 2013, concluded that if you use historical interest rate averages, a retiree drawing down savings for a 30-year retirement using the 4% rule had only a 6% chance of running out of funds. However, when you use the rates from 2013, the chance of failure rose to 57%. Since interest rates have improved only slightly in the last three years, it’s no longer safe to use this rule for retirement planning.
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