JPMorgan Chase says continued inflation and the prospect of significantly lower returns for investors means retirees should ditch the long-standing 4% rule. This is the rule that says retirees can safely withdraw their savings at 4% per year without having to worry about running out of funds before they die. Failure to discard this rule can mean you have to cut back on your spending or even see your savings disappear. Instead, the big bank advises removing no more than 2% or 3% of your nest egg each year. Consider working with a financial advisor as you plan for a worry-free retirement.
What is the 4% rule?
The 4% rule was first formulated in 1994 by financial planner Bill Bengen. It requires you to spend 4% of your retirement savings in your first year of retirement and then adjust that percentage each year for inflation. Doing so would have kept retirees from running out of money in every 30-year period since 1926, even when economic conditions were at their worst, according to Bengen.
For example, a retiree with $1 million in savings would withdraw $40,000 in the first year of retirement. Because all subsequent withdrawals are adjusted for inflation, the same retiree would withdraw $41,200 in his second year of retirement if inflation were 3%.
Why it’s time to throw away the 4% rule.
But earlier this year, Bengen said the 4% rule should be scrapped. And the reasons for doing this are many. For one thing people are living longer. According to the Social Security Administration, the average man turning 65 today can expect to live to age 84.3. His wife can expect to live, on average, to the age of 86.6 years. Research has shown that millennials may live into their 90s and beyond, so there’s even more pressure to increase retirement savings.
The 4% rule also does not take into account individual savings rates. Millennials have the lowest participation rate when it comes to saving in an employer-sponsored plan, and a recent report shows that 56% of them are less likely to save for retirement outside of work. This means that a significant number of young workers could retire.
JPMorgan also advises withdrawing the 4% rule because the prospect of lower yields and higher inflation – “which all economists now see on the horizon” – means the 4% rule could be a recipe for serious financial trouble. While the S&P 500 has gained an average of 10% over the past 10 years, the bank’s recently published long-term capital market assumptions predict a 60/40 portfolio returning just 4.3%.
For example, the bank said there’s almost a 100% chance a 60-year-old with a taxable portfolio of $30 million would run out of money if she spent 4% of her portfolio (that’s $1.2 million) over the next 30 years.
What to do instead
Given the degree of variability in retirees’ spending habits and investment outcomes, JPMorgan offered six factors to weigh as you develop a retirement strategy that’s tailored to you.
Tax Rates – What is the combined federal, state and local tax rate?
Financial Commitments – Are you planning to leave a legacy or benefit your descendants?
Additional Resources – Do you own illiquid but unencumbered assets such as real estate, trusts or inheritance?
Healthcare Expenses – How would you estimate your current medical needs?
Ages of spouses – A 65-year-old couple today faces a 72% chance that at least one will live to age 90, and a 44% chance that the individual will live to age 95.
Portfolio Composition – How much do you have in taxable vs tax-deferred accounts (ie traditional IRA) vs tax-free (ie Roth IRA)? If you have a concentrated position, you may need to spend more to account for this risk to avoid jeopardizing your lifestyle. Maybe you have a lot of built-in profits and will need extra capital to pay taxes when they are eventually sold.
Other analysts have also come up with alternatives to the 4% rule. A Morningstar study found that using an initial withdrawal rate of 3.3%, a retiree with a portfolio split equally between stocks and bonds has a 90% chance of maintaining a positive account balance after 30 years. The more equity-heavy the portfolio, the lower the initial withdrawal rate should be.
The prospect of continued high inflation and sharply lower market yields of 5% or less means that the 4% withdrawal rule should be replaced by one requiring a 2% to 3% withdrawal. Be sure to weigh all relevant factors as you arrive at a withdrawal strategy that fits your risks and assessed needs.
Tips for retirement
A financial advisor can help you find creative ways to enjoy your retirement without spending more than 2% or 3% of your nest egg each year. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors at no cost to decide who is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you don’t have access to a 401(k), consider opening an IRA or Roth IRA as a way to save for retirement.
Photo credit: ©iStock.com/dobok, ©iStock.com/lakshmprasad S, ©iStock.com/AJ_Watt
The post JPMorgan Says You Can Safely Withdraw Both From Your Retirement Accounts Annually appeared first on SmartAsset Blog.