Calhoun County, AL – As a financial planner, besides helping my clients manage their investments, I often help them plan for their retirement. I’ve assisted many people who simply want to know when they can comfortably retire. I typically use a goal-based approach to retirement planning. This involves taking into account the client’s income, expenses, assets, debts, and any goals they envision for their future. I use retirement planning software that helps to project out into the future, which uses certain assumptions such as inflation, investment returns, and life expectancy. By considering all of these numbers and assumptions, a probability of success will be assigned to their specific plan.
I recently had a retirement planning meeting where the client asked me how much money they would be able to pull from their retirement savings on an annual or monthly basis. Using a goals-based approach, there is no perfect answer because certain years require higher distributions than others. However, I did explain to them what’s called the “4% rule”.
The 4% rule is far from an actual rule. At best it is a rule of thumb. Any time you are dealing with a rule of thumb, that means there is no guarantee. However, in my professional opinion, I do feel that the 4% rule does provide some guidance and can give an idea of what a sustainable distribution rate may be during retirement.
The 4% rule was developed in the 1990’s. The 4% rule says this: In the first year of retirement, the client can take an annual distribution of 4% of whatever their total retirement savings are worth at that point in time. The next year, the client can take an annual distribution of the same dollar amount, but adjusted up slightly to account for inflation. By maintaining this distribution rate, their retirement savings should last approximately 30 years. There are some assumptions built into the 4% rule. One of the most important assumptions is that the retirement savings remain invested over the 30-year period in a portfolio composed of 50% stocks/equities, and 50% in bonds. This assumption is based on historical market returns, which of course are not guaranteed and not indicative of future returns.
Below is an example of a 4% rule in action:
Jane Doe retires at age 60 with $500,000 total in retirement savings. Her accounts are invested in 50% stocks and 50% bonds. Inflation is assumed at about 2.5% a year throughout her retirement.
Year 1 distribution: $500,000 x 4% = $20k annually ($1,667 per month)
Year 2: $20,000 increased by 2.5% inflation = $20,500 annually ($1,708 per month)
Year 3: $20,500 increased by 2.5% inflation = $21,013 annually ($1,751 per month)
It’s important to remember that the 4% rule is simply a rule of thumb. If market returns are vastly different than historical returns, 4% may be too high of a distribution rate to be sustainable for the long-term. A qualified financial planner, such as CFP® professional, should be able to assist you with adequately planning for retirement. I hope you have found this article insightful.
Editor’s Note – Jonathan T. Jones® is a local financial advisor who will be a contributing author for the Calhoun Journal. He will be writing financial pieces to help readers understand the market and many changes that are currently happening in the financial world.
Jonathan T. Jones, CFP®
Wealth Manager/Financial Advisor, RJFS
501 Quintard Avenue, Suite 17
Anniston, AL 36201
Any opinions are those of Jonathan Jones, CFP® and not necessarily those of Raymond James.
Securities offered through Raymond James Financial Services Inc., member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Wealth and Retirement Services is not a registered broker/dealer and is independent of Raymond James Financial Services.