Did you know that once you’ve retired the government requires you to sell off 4% of your retirement money every year thanks to the “4% rule?”
Yay, another arbitrary rule to live by, amirite?
The 4% rule has a long and kinda complicated history.
It’s supposed to be a way to determine how much retirement money you can safely spend per year without running out.
But, mostly, it just sounds like another way for people to tell me what to do with my money.
Basically, while you’re dreaming about how to spend your golden years, there are rules like this one being put in place to keep you from using the money you’ve worked so hard to amass.
While it’s wise to think strategically about how to spend (and save) your retirement money, there are also ways to keep from being completely without financial freedom.
After all, you want to actually use that money for what you saved it for: your well-earned retirement.
Understanding the 4% Rule
While managing your retirement funds depends on a lot of factors — how much you’ve saved, your portfolio, how well your investments are doing, etcetera — over the years society has developed “rule of thumb” strategies for retirement management.
The general idea of the 4% rule is that any given person should be able to safely withdraw 4% from their retirement money annually without severely depleting their funds.
This means that the remaining money will (theoretically) earn almost as much as you withdraw each year and you’ll continue to have income for as long as you need it.
So, if you have $700,000 in your portfolio, you’ll want to withdraw $28,000 in your first year of retirement. If you adjust for 3% inflation the next year, you withdraw $28,840. And so on.
Sounds good, right?
As a guideline, sure.
This rule is supposed to ensure that you don’t outlive your retirement money.
But, this assumes that your portfolio is capable of making back what you withdraw each year, which can be impacted by a variety of factors — not the least concerning of which is constant market fluctuations.
It also assumes that you only need 4% to live on. Or that your portfolio is large enough to accommodate 4%. It assumes a lot.
Your portfolio has a hard time making it back when there’s less money earning because you’re selling it off every year to live.
So, this method can be… oh, let’s go with “unreliable”… and hella expensive when you factor in taxes.
Oh, yeah. Did you forget about those?
So not only are you required to make a minimum withdrawal from your retirement portfolio, those withdrawals are taxed.
Before you know it, you’re out of money when you really need it.
When that happens, what was the point of all of those years of careful saving?
That’s why it’s good to not only take this rule with a grain of salt, but to understand all of your options.
The History of the 4% Rule
The rule used to be that 5% was a safe amount to withdraw each year. However, financial advisor William Bengen started to wonder about the accuracy of this rule and conducted a study using historical data on stock and bond returns from 1926 to 1976.
Bengen was specifically curious about whether huge market downturns in the 30s and 70s impacted the rate at which retirees should spend their nest egg.
Long story short, he found that no matter how unstable the market was, any retirement portfolio could withstand a 4% annual withdrawal for at least 33 years without being depleted.
Voila. The 4% rule.
So, once again, some dude from the olden days decided what we should be doing with our money and we’ve just stuck with that ever since.
Cool. Now what?
Does the Rule Still Apply?
It does if your retirement is invested in a traditional 401(k) or IRA.
And here’s the problem if you’re investing that way and only investing for capital gains (the increase in share price) instead of investing for income (the income the share produce regardless of share price) – one big market drop in retirement and you’re toast.
That’s why we recommend ditching the arbitrary rules entirely.
If you use a Roth IRA account and a solid income investment strategy like say our Infinite Income™ method, you can leave your portfolio intact and live off the income tax-free (our favorite words ever).
Let’s face it, retirement can be a big old scam.
It’s just another way to ensure we never actually see our money. But with the right strategy, you can take complete control of your financial future — without the stress of taxes and the government forcing you to sell off your investments.
The most important thing you can do is start investing early and make a plan now.
I guarantee you that when you’re a retired babe you’ll never think “I sure wish I hadn’t saved all that money.”