Building up a nice nest egg is only part of the process when it comes to setting yourself up for a financially sound retirement. It's just as important to manage your savings wisely.
To that end, you may be inclined to follow the 4% rule. It's one that financial experts have long stood behind and an easy strategy to follow. The problem is that it just may not work for you.
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What the 4% rule entails
The 4% rule tells you to remove 4% of your retirement plan balance your first year of retirement, and then adjust future withdrawals based on inflation. So with a $1 million IRA or 401(k), you'd take out $40,000 your first year of retirement. And if inflation rises close to 3% over the following year, your next withdrawal would be more like $41,000.
The 4% rule certainly takes a lot of complexity out of the mix with regard to managing retirement savings. But that doesn't mean you should use it.
The problems with the 4% rule
While the 4% rule might work for some people, there are a few reasons it may not work for you. First, the rule is based on a retirement portfolio that's pretty evenly split between stocks and bonds. If you have a more conservative portfolio, you may not get enough growth in it during retirement to support a 4% withdrawal rate.
The 4% rule also makes assumptions about bond yields that may not apply once your retirement kicks off. If bond yields fall, a 4% withdrawal rate may be too aggressive.
Another issue with the 4% rule is that it doesn't account for your specific expenses and goals, and when they might arise. You may have things you want to spend money on -- like travel -- early in retirement, when your health is better. In that case, you need a withdrawal strategy that gives you the flexibility to take larger distributions during the early stages of your senior years.
You may also not end up retiring at a conventional age. The 4% rule is designed to help your savings last 30 years. If you're closing out your career at age 50, you may need your nest egg to last longer. And if you love what you do for a living and decide to stay at your job until age 75, you may not need your savings to last that long.
A better approach
There's nothing wrong with reading up on the 4% rule and perhaps using it as a starting point for managing your savings. But also think about the rule's limitations and come up with a withdrawal plan that accounts for them. And it's definitely not a bad idea to work with a financial advisor to arrive at a strategy that's targeted toward your specific needs and goals.
If there's one solid takeaway from the 4% rule, it's that you need some sort of plan for managing your savings once you retire. You shouldn't just start tapping your IRA or 401(k) at random and hope for the best. But you may find that an alternative approach to managing your money works better.
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