September 27, 2022

Also, what the 4% rule might look like in practice.

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In July, I wrote this column about a guy who was working with a financial planner and was withdrawing 4% from his investment accounts, but it wasn’t enough, and he was wondering if he had to get one. Got a new advisor. A big point brought up in the column was this: People often misunderstand the 4% rule for a variety of reasons – and if your financial advisor isn’t explaining it clearly to you or telling you its alternatives, it’s time to change advisors. may be the time. (Looking for a financial advisor? You can use this tool to match you with a financial advisor who can meet your needs here.,

What is the 4% Rule?

The 4% rule – developed in 1994 by financial advisor William Benzene – suggests that you start retirement withdrawals at 4% of your assets and increase withdrawals annually according to what is happening with inflation. regardless of what happened in the stock and bond markets. “The cost of the things we typically buy increases every year, so it makes sense to have a withdrawal strategy in mind,” says Curtis Bailey, certified financial planner at Quiet Wealth Management.

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Simply put, the 4% rule is considered a safe withdrawal rate, says accredited asset management expert and accredited investment fiduciary Ted Halpern of Halpern Financial. “You can safely, assuming long term, withdraw 4% per annum without money. There will be years where you will go into your original investment, such as is likely this year, but in the long run it will be a safe The figure is there,” Halpern says.

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Here’s what the 4% rule might look like in practice: If the initial portfolio is $1,000,000, the first year withdrawal would be $40,000. Now suppose inflation looks like this: 1%, 2%, and then 3%. Based on 1% inflation, the next year’s withdrawal would be $40,400 (that’s $40,000 x 1.01); With 2% inflation in the following year, this would increase to $41,208. In the end, it will be $42,444 based on the 3% rate.

What are the misconceptions about the 4% rule?

There are also two common misconceptions about the 4% rule, say professionals. “The first is that 4% is total withdrawals – taxes and advisory fees need to be paid as part of the withdrawals,” Bailey says.

But the reality is, as Charles Schwab aptly puts it: “The rule dictates how much to withdraw from your portfolio each year and assumes that taxes or fees, if any, are an expense that you can withdraw.” If you withdraw $40,000, and have $5,000 in taxes and fees at the end of the year, that’s paid with the $40,000 withdrawal.” But that means you’ll need to consider that you may end up with less than you thought: “If you’re paying 1% to your advisor, that’s only 3% of you for expenses and taxes.” % will drop,” Bailey says.

The other big misconception is that the 4% is calculated only once at the beginning of the first year, and you start over with the same amount every year, regardless of the portfolio value, Bailey says. Says Bailey, “Assume a family has a total portfolio of $1 million at retirement — the first year withdrawal is $40,000.” Assuming 2% inflation, in the second year, you would withdraw $40,800, which is the principal amount with 2%, and in the third year, you would withdraw $41,616, which is $40,800 with 2% tacked on. And Bailey says: “This amount is calculated regardless of your current portfolio value, whether it’s up or down significantly,” Bailey says.

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What are the main criticisms of the 4% rule?

The rule disregards the performance of an individual’s portfolio. In fact, it multiplies your spending by the rate of inflation each year rather than the performance of your portfolio — which can cause problems for some investors. “What happens when you need to replace your furnace or ceiling? Or what if you want to make a big trip in your third year of retirement? The rule doesn’t answer that,” Bailey says.

It also assumes a time frame of 30 years, which may not be relevant to you depending on your health and other factors. And it is based on calculations that use historical market returns (which cannot predict the future) and a sample portfolio of 50% stocks and 50% bonds.

What else should aspiring retirees consider?

An important takeaway from the 4% rule is that inflation is at the heart of retirement. “It makes sense to think about not only how inflation affects spending but also how your portfolio is oriented to meet or surpass inflation. Inflation doesn’t care what happens in the markets. But your lifestyle does,” Bailey says.

There is one more thing to consider. “Taking withdrawals from brokerage accounts can lead to lower total withdrawals than retirement accounts because you have to pay all taxes on the brokerage account. An advisor will help you determine this,” says Anthony Ogorek, certified financial planner at Ogorek Wealth Management. What can help determine what is the most beneficial mix of draws from taxable and non-taxable accounts.”

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