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Retirement Planning: The 4% Retirement Withdrawal Rule December 1, 2008

Posted by retirementwithaplan in retirement.
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The often quoted rule: if you withdraw no more than 4% of your retirement account balance in a given year, you will never run out of money may be in trouble if you have not put enough money in the account to give you a living income.

Take a look at the table below:

Retirement Savings All Ages 25-34 35-44 45-54 55+

Less than $10,000

36%

49%

33%

29%

28%

$10,000-$24,999

13%

18%

13%

11%

8%

$25,000-$49,999

12%

14%

12%

13%

7%

$50,000-$99,999

12%

13%

12%

10%

16%

$100,000-$249,999

15%

4%

21%

18%

18%

$250,000 or more

12%

2%

8%

20%

23%

Source: Retirement Confidence Survey, April 2008.

Can you find your current retirement savings? If so, the rule I often apply for withdrawing money in your retirement, the 4% withdrawal rule, will leave you far short of where you need to be.

How we plan

For many of us, the tendency to look beyond those numbers in retirement accounts become part of an overall plan. Few, if any of us will rely solely on what we have socked away. We have lumped together the expected payout we might receive from Social Security, calculated the relative worth of our homes and the equity it represents and may even be adding the payments that a company sponsored pension might add to the overall total. But have you done the math correctly, accounting for what might happen, what we can expect to happen, and whether a slight miscalculation might lead to a financial disaster long after our working years are done?

The 4% withdrawal rule offers a glimpse of a plan that guarantees we will not run out of money. What we need to make this rule work, is enough of a living return to make the math work as we hoped.

The bad news is that it won’t work if you fall among the typical 40-year-olds in the chart above. That average retirement account of $25,000 given a generous market place return of 10% – an historical average that we now know is not consistent year-over-year and in many cases, may not hold sway in the coming decade – would give you just shy of $350,000 in that account at age 70. That’s right, age 70, the year when you will be forced to take distributions.

To withdrawal from that account using the 4% rule would leave you with a paltry $14,000 a year to live on or about $1,200 a month. If you assume inflation will be eating away at that $1,200 the same way it has for the last thirty years, the worth of that withdrawal will look more like $320 a month.

To account for the inflation rate, you will need to add it the withdrawal rate as well. If inflation remains at 3%, a figure that is often the target umber used by the Federal Reserve, your withdrawals, year over year would increase.

$14,000 X 1.03 (the current withdrawal with inflation added in) = $14,420
and it would continue
$14,420 X 1.03 = $14,882
$14,852 X 1.03 = $15,298

Before long, the account would run dry, eliminating the 4% rule in its path.

More than Inflation

Other things that will take a chunk away from your plan are taxes – and these will increase both on a state and government level. The only problem with those increases, is determining how they will subtract from what you had planned to use for your everyday life.

Social Security will be there for most of us but if you are forty, it may not be what you were counting on. Some of us will rely on pensions for to make up some short falls.

The bottom line is simple enough to see. You will need to increase your retirement investments now, pushing the envelope a little harder than you might want to or think you can afford. These markets currently represent the buying opportunity of a lifetime and you would be foolish to not take advantage of some historically low prices.

If you are saving 10%, you will need to increase it 15% and keep it there until you retire. If you are saving less that 10%, increase your contribution and add in any pay raises you get over the next twenty to thirty years to keep it funded.

If you are planning on a $50,000 income when you retire, and inflation alone takes its toll on those withdrawals, you will need to be able to take $150,000 out using the 4% rule. This means, your retirement account will need more than $3.75 million in it when you stop working.

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