A few times every year a new client walks into Keen Wealth so excited to start planning and saving that they think they’ve already done the work for me!
They show me this big, beautiful spreadsheet they’ve put together that has everything: salaries, assets, liabilities, cash in the bank, investment accounts, their whole financial picture.
So far so good!
But then they flip to the next page, where they’ve projected their finances in retirement. Usually the spending rate is represented by a flat line on a graph, or the same number – 4% – used over and over to calculate an annual spending rate.
“Why did you pick 4%?” I’ll ask.
“I read online that you should withdraw 4% every year in retirement.”
You’ve probably read about “the 4% Rule” in your own retirement research. But before you let that number get stuck in your head, let’s dig into where 4% came from, its uses, and most importantly, its limitations.
The Origins of the 4% Rule
Believe it or not, the 4% Rule used to be … the 5% rule! It was close to accepted wisdom among financial advisors through the early 1990s that retirees could withdraw 5% per annum without worrying too much about jeopardizing their security.
Then, in 1994, a financial advisor named William Bengen decided to put this maxim to the test. He analyzed historical stocks and bonds return data from 1926 to 1976, while also focusing on what happened during severe market downturns in the 1930s and 1970s. Bengen couldn’t find a historical case during which a retiree who was withdrawing 4% every year exhausted his or her nest egg in less than 33 years.
Thus, the 4% Rule was born. To this day, plenty of financial advisors still use 4% as a quick and easy shortcut to building a spending plan for clients. After all, as the saying goes, if it’s not broke, don’t fix it, right?
The Limits of 4%
A nest egg that lasted no less than 33 years sounded pretty good in the early 1990s, when most folks were retiring at age 65 and supplementing their personal savings and investments with pensions from their employers.
But a lot has changed since the 1990s. For starters, folks on fixed incomes today have to deal with low interest rates, especially in the bond markets. Pensions are mostly a thing of the past, and retirement planning is becoming more and more of a personal responsibility.
Also, thanks to advances in health care, exercise, and nutrition, folks are living longer today than they ever have. In fact, many experts project that the world’s centenarian population is going to grow dramatically in the next few decades. And the longer you live, the more of your nest egg is going to have to cover the health care costs that Medicare won’t.
Then there’s the growing group of folks who are trying to turbo-charge their retirement savings and retire early. Some millennials who subscribe to the FIRE movement – that’s Financial Independence Retire Early – want to stop working fulltime as early as age 40! I’m still skeptical that FIRE folks will be as happy and secure in retirement as they think they’ll be. But there are plenty of older professionals who retire before age 65 because they have the means to do so, or because they’re forced into early retirement by a health issue or unexpected job loss. Is a 33-year-long nest egg going to cut it?
Finally, the 4% Rule assumes that your spending will increase with inflation at a linear rate as you age. From a tax perspective, we no longer use the same mechanisms for calculating inflation that we did in the 1990s. And from our view in the trenches here at Keen Wealth, I can tell you that retirement spending in general just doesn’t work like this anymore. Because today’s retirees are healthier and more active, they’re likely to spend more money early in retirement when they’re still able to travel, play sports, and pursue their other interests. Once retirees start to slow down, their spending typically slows down too.
Checklists or shortcuts?
When folks ask me about the 4% Rule, I tell them that it’s a good place to get started if you’re just trying to do some “back-of-the-napkin” calculations about your retirement spending plan. It’s a handy shortcut, but it’s still a shortcut.
And as you probably know if you’re a regular reader and listener of the Keen on Retirement podcast, we don’t do shortcuts at Keen Wealth.
We do checklists!
Once we get past accounting for your raw financial numbers, our checklists move on to the things that will really determine what your retirement withdrawal rate should be. We’ll ask you things that you might not think are a part of your financial plan, like:
- What are your hobbies?
- What sports do you play?
- What are you passionate about?
- How is your health? Your spouse’s?
- What is your family history?
- Do you want to work or volunteer in retirement?
- Are there any big trips you want to make early in your retirement?
- Who are the important people you want to spend more time with when you retire?
- What does your ideal week in retirement look like?
No financial advisor can plot these answers like a straight line, because life doesn’t move in a straight line. Your retirement will be no different. Old interests will fade and be replaced by new ones. There will be ups and there will be downs. You’ll enjoy perfectly planned vacations and will likely also encounter unexpected challenges like illnesses and home repairs.
And through it all, Keen Wealth will be there to help you recalibrate as necessary so that you keep getting the best life possible with your money. No shortcuts, no rules of thumb, just our experience and a checklist-driven process that you can trust.
Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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