The 4% Retirement Rule Makes a Comeback
A recent analysis from Morningstar tells us that after years of caution due to low interest rates and volatile stock prices, retirees can once again feel comfortable following the classic 4% rule for withdrawing funds from their retirement portfolios.
The 4% rule is a widely used guideline that suggests retirees can withdraw 4% of their nest egg in their first year of retirement and adjust that amount annually for inflation in subsequent years. This strategy is designed to provide a steady income stream while preventing retirees from outliving their nest egg over a 30-year retirement period.
The Return of the 4% Rule:
Morningstar's analysis found that a balanced portfolio of stocks and bonds can again safely support initial withdrawals of 4%, thanks largely to higher bond yields stemming from the Federal Reserve's interest rate increases. Due to unfavorable market conditions, Morningstar had recommended lowering the initial withdrawal rate to 3.3%.
The 4% rule fell out of favor in 2022 as inflation, falling bond prices, and tumbling stock valuations made it riskier for retirees to sustain their level of spending without depleting their savings prematurely. Nowadays, stabilizing inflation, higher yields available on bonds, and above-average stock returns provide more cushion and stability for retirement portfolios.
What This Means for Retirees and Pre-Retirees:
The revival of the 4% rule is welcome news for those nearing retirement, allowing retirees to generate more annual income without excessive risk. However, it’s a general guideline and may need adjustments based on individual circumstances. Here are some key considerations:
- Revisit your retirement income plan: Consider increasing your withdrawal rate if you had previously lowered it.
- Consider a flexible withdrawal strategy: Adapt to market conditions, such as forgoing down-year inflation adjustments.
- Maintain a diversified portfolio: Ensure a balanced mix of stocks and bonds to manage risk and generate income.
- Review your overall financial situation: Include Social Security, healthcare costs, and longevity risk in your planning.
While the 4% rule's resurgence is positive news, working with a qualified financial advisor is crucial to developing a personalized retirement income strategy that aligns with your unique circumstances and goals. A well-crafted plan can help ensure your savings last through retirement.
Side note: while we were pleased to see that Morningstar has regained its comfort level with 4% withdrawals, long-term studies show that this withdrawal rate is designed to accommodate bad years like what we experienced in 2022. If you’ve got questions about cash flow, we would welcome the chance to talk to you.
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