When financially planning for retirement, many people are focused on their social security, their 401k, and the many other factors that determine how much they will have to withdraw once they’re done working.
However, one thing that many people forget to consider is how to have a financial plan to manage your retirement funds. This puts many people at risk for overspending and running out of retirement money too soon. However, there is a strategy available that allows you to maintain a steady stream of retirement income called the 4% rule.
What is the 4% rule, and how can it help you maximize your finances when retired? Read on to find out!
Why 4%?
The 4% rule is based on a study that showed that 4% is the max amount you can withdraw from your retirement accounts, and still maintain consistent savings over a 30-year period. This means that larger withdrawal amounts of over 4% put account holders at risk of running out of money in retirement before 30 years. While this is only a rule of thumb, it does give people a good estimate of what they can and can’t withdraw in retirement to maintain stability.
This amount also takes inflation into account, as well as any drops in the market value of your retirement account. This means that by following the 4% rule, you will still be able to increase the amount you're withdrawing by a small margin to match the price of inflation over a 30-year retirement period. You will also have a buffer in case there is serious turbulence in the market, causing your retirement account’s value to decrease in the short term.
How much will this give me?
In order to know what 4% of your retirement is going to look like for you, you should first take a look at what you have saved for retirement. If you have $1 million in a 401k account, and another million in a Roth IRA, withdrawing the maximum of 4% will leave you with 80,000 a year.
For some people, sticking to 4% will be more than enough to cover their expenses. If this is the case, they can often be comfortable sticking to far less, such as a 3% withdrawal, or even a 2% withdrawal. If they do this, they’ll have a lot more retirement savings to work with for a longer period of time. However, for others, the 4% won’t be enough to maintain their current lifestyle, and they’ll need to look to reduce their costs or see if they can safely withdraw more and still have enough to cover their retirement. Some people find that the best option for them is cutting their spending, or even downsizing (or rightsizing) for retirement.
It’s also important to consider accounts other than your 401k or IRA, such as your social security benefits. The average social security payout is about 18,000 a year. This can help cover additional expenses, allowing you to withdraw less from your retirement accounts if you’d like to save more. For example, if a 4% withdrawal leaves you with 40,000, plus an additional 18,000, and your yearly expenses are only 40,000, you can stick to a 3% withdrawal and use social security to supplement the additional amount.
How do I stick to this plan?
Once you’ve determined how much you’ll get as your yearly retirement income, you need to make sure you’re able to live within your means during this time period. This will first and foremost require you to get an idea of what your monthly spending should look like. To do this, take the total amount you will have available to you on a yearly basis in retirement, and divide that amount by 12 to determine a basic monthly spending amount.
You can allocate those funds between your monthly expenses, such as food, housing, and other necessary bills. If you find that the 4% rule has left you with more than enough to cover all necessities, while still having enough for other retirement activities like travel and socialization, you can put the additional amount back into your retirement account for more savings!
It’s also important to keep up to date on your accounts and your spending as you go along, because if you overspend it may dig into your retirement savings more than you’d like it to. Make sure you have a way to track your payments, by keeping an up-to-date checkbook, or by using online-only bank accounts that give you instant updates every time you spend money. Doing these things will give you a good idea of what your average spending is like so you can avoid overspending.
What about financial emergencies?
Of course, financial emergencies are bound to pop up, even in retirement. This can be especially concerning when you have a 401k, because depending on how the market performs, you may lose money if the stocks you’re invested in drop.
While the 4% rule takes these into account, there are still going to be hiccups to be prepared for. This is why it’s important not to keep all your eggs in one basket. Having a diverse portfolio of not only a 401k, but also a separate emergency fund in a money market account could be the extra safe haven you need to have money for emergency losses.
The 4% rule is a great guide to have as you plan to withdraw money in retirement. By sticking to a structured plan to manage your retirement funds, you’ll be able to make the most of your savings and enjoy your retirement to the fullest!