It's time to get with the program and know what financial advice not to use.
Many people find themselves nearing retirement without much money socked away in savings. This is unfortunate, but hopefully, you're in a much different boat.
Maybe you're approaching retirement with a $500,000 nest egg. Or perhaps you've managed to amass $1 million in your IRA or 401(k) plan.
No matter how much savings you're bringing with you into retirement, it's important to make sure that the money lasts. And that means ignoring one glaringly outdated rule and opting to follow a more appropriate one.
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Forget the 4% rule
For many years, financial experts talked up the 4% rule in the context of retirement savings. The rule was simple and went as follows: In your first year of retirement, you'd withdraw 4% of your IRA or 401(k) balance. You'd then adjust all subsequent withdrawals to account for inflation. If you stuck to that system, you'd be setting yourself up to have your savings last for 30 years.
The 4% rule was a good one when it was established back in the 1990s. But the rule is now flawed for a few reasons.
First, it assumes a relatively even mix of stocks and bonds. Not every retiree has that sort of asset allocation these days.
Secondly, bonds were paying a lot more interest in the 1990s than they're paying today. And a portfolio that's heavily loaded with bonds may not generate the same returns as it would've years ago. As such, it may not be able to provide the same level of annual income.
Use the 2% rule if you're looking at a longer retirement
While the 4% rule may have been an appropriate one to follow back in the day, at this point, you're probably better off being more conservative -- especially if you're planning for early retirement. If that's the case, you may want to play it safe by using the 2% rule. It goes just like the 4% rule, only you start by withdrawing 2% of your nest egg's balance the first year of your retirement.
Use the 3% rule if you're looking at a more average retirement
Maybe you're not retiring early but on time. If that's the case, you might fare well by following the 3% rule, where you remove 3% of your savings balance the first year you're no longer working and take it from there.
Prepare to be flexible
No matter what withdrawal rate you start with, you can always make adjustments as retirement rolls along. Let's say you begin by removing 2% of your savings balance, but your portfolio winds up performing far better than expected. If you come to that realization after a few years, you can always adjust your withdrawals to allow for a higher annual income from savings.
On the flip side, if you find that your portfolio is underperforming and you're worried about depleting your savings, it could pay to scale back your withdrawals over time. The key is really to remain flexible either way and make decisions based on how rapidly (or not) you're spending your savings.
You could even decide to start with the 4% rule and see how it goes. But doing so could mean running out of money sooner than you'd like. While the 4% rule may have been sage advice back when it was established, these days, you're better off landing somewhere in the 2% to 3% range.
