Planning for your retirement can be a daunting prospect, but it’s a crucial part of ensuring you’ll be financially stable during your golden years. Through the planning process, you’ll determine how much money you’ll need during retirement, how much you can realistically save and how to invest it to achieve your goals.
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If you’re close to retirement or have just gotten serious about planning for it, you’ve probably already come across the term “safe withdrawal rate.” This is the rate — usually expressed as a percentage — at which you can take money out of your retirement savings every year without depleting your savings so much that you risk being unable to fund your full retirement.
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What Is the Safe Withdrawal Rate?
The concept of the safe withdrawal rate primarily comes from the Trinity Study published in 1998 in the Journal of the American Association of Individual Investors. The study’s authors looked at historical rates of return to determine what percentage of retirement funds you could withdraw each year without running out of money over a 30-year period. Its research concluded that the answer was 4% — for this reason, you will often hear the safe withdrawal rate referred to as the “4% Rule.”
“Here’s how it works: If you have $1 million, you can take out 4% each year ($40,000) over a 30-year retirement. It is a rough number that helps to give people a place to start. If you follow the safe withdrawal rate math, you can use the inverse to figure out how much you need to retire by multiplying your current annual expenses by 25. So if you are spending $40,000 a year on your expenses, you need $1 million to retire,” said Jay Zigmont, PhD, CFP, and founder of Childfree Wealth.
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Personalizing Your Withdrawal Strategy
While the 4% rule is a good starting place, it’s not necessarily right for everyone. Every retiree’s finances are different, and your safe withdrawal rate might be higher or lower than 4% depending on your unique situation.
“Flexibility in retirement planning is crucial. This means being open to adjusting withdrawal rates in response to the financial market’s performance. For instance, in a low-interest-rate environment, withdrawing 4% annually might be too aggressive and risk depleting retirement funds prematurely. Conversely, in a robust market, this rate might be overly conservative, limiting the potential lifestyle retirees could enjoy,” said Dominic James Murray, financial advisor and CEO of Cameron James.
External factors aren’t the only thing you need to consider when you are planning out your withdrawal strategy. Internal factors like your lifestyle, location and estate plans are equally important to the equation.
“I work with [people] who don’t have kids and aren’t planning on having kids. Most childfree people do not have a goal of passing on money to the next generation and they adopt something akin to a ‘Die With Zero’ approach. If you don’t want to pass on money to the next generation, the 4% rule doesn’t fit, as a core assumption is that you want to maintain your principal,” Zigmont said.
The Importance of Regular Checkups
Your true safe withdrawal rate is all about finding a balance between having adequate income to support your desired lifestyle while ensuring that your retirement savings can continue to grow enough to maintain its value against inflation and last the rest of your life.
“The bottom line is that the safe withdrawal rate of 4% can give you an educated guess of your retirement needs, but it will vary based upon your life, taxes, and more,” Zigmont said.
Even after you’ve planned out the withdrawal rate that’s right for you, make sure you are giving your plan regular checkups. Life changes quickly, and your financial plans may need to be adjusted accordingly. Downturns in the economy, a change in your health or an unexpected major expense all might require a shift in strategy.
Working With an Advisor
If determining your withdrawal strategy feels overwhelming or you just don’t know where to begin, don’t be afraid to seek the help of a professional financial advisor. A good advisor can provide sound, personalized advice at every step of your retirement journey.
“It’s about building a relationship where we navigate the complexities of retirement together. I’m here to listen to your concerns, celebrate your milestones, and adjust your financial plan as your life evolves. Retirement is a significant life transition, and having someone to guide you who is invested in your financial well-being and understands the nuances of your financial journey is invaluable,” Murray said.
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This article originally appeared on GOBankingRates.com: Retirement Planning: What Is the Safe Withdrawal Rate?
