Advisors Discuss the ‘4% Rule’ and Top Retirement Tips

For those ready to make the retirement plunge, it’s essential they see their financial plan as a “living, breathing” one. That way it can accommodate market changes or other life fluctuations. They should also make sure to spread their nest egg across a diversified portfolio of accounts with varied tax liabilities, advisors shared.

Aaron Clarke, a wealth advisor at Gainesville, Virginia-based Heritage Financial, recommended that individuals heading into retirement review two key things. The first is the location of their assets. The second is how they can adjust their withdrawal plans to accommodate for the markets.

“You don’t know when the market might be down or up. If you are plus or minus three to five years of your retirement date, there’s a very big risk in that particular set of years,” Clarke said. “If you retire, and the market goes down by 20%, you taking out the standard amount in any given year will represent a bigger percentage of your portfolio.”

In other words, he looks at this as strategizing “how are you planning to avoid shooting yourself in the foot,” based on significant dips in the markets.

Where Are Your Retirement Assets?

He also recommended that new retirees take a hard look at the location of their assets largely due to tax implications. Essentially, he said they should consider how their retirement money is allocated across different kinds of accounts.

“If you have an IRA with $500,000 in it, you don’t have $500,000 to spend. You have $500,000 minus tax. If you can keep your tax bracket as low as possible, then your portfolio will last longer. I call that portfolio longevity,” Clarke explained.

It may not be a good idea, for instance, to have your retirement distributions set up to come solely from one account because it is your biggest account, he added.

“It might be best to take a little from a Roth IRA, a brokerage account and tax-deferred accounts, such as a 401(k), even if some of those accounts are small,” Clarke noted, as withdrawing large sums of money from a tax-deferred account could push individuals into a higher tax bracket, depleting their nest egg even faster.

The 4% Debate

Clarke also recommended that those entering retirement aim for a 3.5% annual withdrawal target in their first year of retirement.

Despite the long-standing, yet debated, 4% rule — which suggests individuals should cap their annual withdrawal to 4% of their nest egg in their first year of retirement to ensure their money will stretch the length of their retirement years — Clarke said he prefers to err on the side of caution.

“Three and a half percent is a better withdrawal target to preserve principal balances. But since rates have adjusted up, 4% has been reestablished as the norm. [However,] I prefer conservative estimates, personally,” he said.

It’s important to understand historically where the 4% came from. That was established when interest rates were much higher than they’ve been for the past several years,” Clarke added.

Kenneth Chavis IV, a senior wealth counselor at Versant Capital Management, said he generally believes that the 4% rule can still work. However, he added that it’s important to note that the rule (introduced in the 1990s by financial advisor Bill Bengen) was based on a traditional 60/40 stock and bond portfolio.

“The 60/40 asset allocation is the biggest component of whether that 4% rule applies to an individual,” he said. And after the first year of retirement, that 4% should be adjusted for inflation each year, Chavis noted.

“In practice, what I’ve seen is that [rule]definitely holds. But it really depends on a number of factors, whether that is the maximum someone should be [withdrawing]. It depends on their age, their expected longevity, and what you may get from Social Security in the future. Some people may receive an inheritance. Some people might remove that inheritance from their future planning,” Chavis explained.

Read More: Early Retirement Needs Careful Consideration, Planning

Making Your Assets Last in Retirement

“If someone is retiring relatively young, say in their 40s and 50s today, there is a debate in the financial planning industry of how much of that Social Security benefit will be there in the future,” Chavis said of other factors impacting their withdrawal assumptions.

“I would say for folks to model something conservatively. It’s better to assume you may be getting a little less than you’ll actually be getting, which is a general rule,” he added.

A Gallup poll released in December found that Americans were more optimistic than in past years about the Social Security benefits they’d receive upon retirement. Among nonretirees in the U.S., 50% said they expected to get Social Security benefits. That’s a higher percentage than in similar surveys done in 2005, 2010, and 2015.

Overall, the poll still showed that nearly half of nonretirees in the country did not believe the Social Security system would be able to pay them a benefit when they retired. That’s a sobering snapshot of public attitudes.

Some retirement savings news has felt more promising.

In November, Morningstar published a report that found retirees may now be safe to aim for the 4% target again. The research determined the 4% rule would still leave retirees with a 90% probability of having enough funds to cover a 30-year retirement horizon.

The 2023 research produced the highest safe withdrawal percentage (4%) since Morningstar began its research in 2021. (The highest “safe withdrawal rates” were 3.8% in 2022 and 3.3% in 2021.)

The adjusted target was due to increased yields on bonds and cash and “a more moderate inflation outlook,” which helped boost the safe withdrawal rate, a Morningstar report said at the time.

When to Tap the Emergency Fund

Should a big-ticket, unexpected expense arise, Chavis said that retirees should be tapping their emergency funds. This is a better option than relying on assets in tax-deferred accounts.

You still want to make sure you have an emergency account that is liquid. That may be a high-yield savings account or a money market account that is set aside with at least six months of living expenses. To me, that still applies to retirement life. For unexpected expenses, that would be a good place to draw from,” Chavis said.

The biggest piece of advice he has for anyone retiring is to make sure they continue to update their long-term, comprehensive financial plan with a qualified advisor or certified financial planner.

Individuals should aim to review their financial plan at least once a year, barring any significant life changes, Chavis noted.

“The plan you have is really dynamic. It’s a living, breathing plan. It should be updated regularly, because you run it once and I wouldn’t say it is static and stays there. Life happens, and your objectives or goals change. The market dynamics may change over certain periods of time,” he continued.

“Other considerations may be looking at a scenario where we have an extended bear market. Or in the first few years when you retire, the market has a pretty big correction. Consider, even if things were to play out in that way, would my assets stretch for the duration of my life?” said Chavis.

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