Does the so-called 4% Rule work during a market as crummy as this one? When inflation is sky high and the market is lower than a hound dog's nose?
Can you still withdraw 4% — which IBD has explained in prior reports is supposed to be really 4.7%, according to now-retired financial advisor and rule inventor Bill Bergen — in a year when the stock market slashes lots of value out of your account balances, without crippling your savings' ability to support you for decades to come?
This year, it might be better to follow your gut. Trim your withdrawal. Leave as much money as you can afford to, in order to stay protected inside your tax-sheltered retirement accounts. That's what many leading financial advisors say.
After all, the market is down 14% this year. If you withdraw 4.7%, that's like pulling a whopping total of 18.7% from your retirement nest egg.
That can make it mighty tough for your retirement savings to survive for the 30 years that the 4.7% Rule envisions.
Inflation Danger
That's why many financial advisors recommend trimming your annual withdrawal. Take some pressure off your retirement savings. Leave more of it in place, ready to rebound when the market rallies and inflation eases.
Still, the temptation to withdraw more, not less, is big.
After all, you've not only got a nasty bear market to deal with. You've also got harsh inflation. You need more dollars to pay for things. And the latest government figures put inflation at a corrosive 8.5% yearly pace.
How bad is that much inflation? Let's say inflation stays this high, even though that is very unlikely. Still, if it does happen, after just five years, the purchasing power of every $100 in your nest egg would shrink to a mere $66.41, according to the inflation calculator at calculator.net.
How The 4.7% Rule Works
Here's how the 4.7% Rule is supposed to work. In the first year of retirement, you withdraw 4.7% of your retirement savings.
In year two — in normal market conditions — "after the first year you 'throw away' the 4.7% rate and work purely with dollar withdrawals and inflation rates," Bergen told IBD. "Thus, in year two, the dollar withdrawal is equal to the dollar withdrawal in year one adjusted for inflation."
Say your retirement savings totaled $2 million in year one. Your 4.7% year-one withdrawal would have been $94,000.
If inflation in year two is 8.5%, your year-two withdrawal would be $94,000 times 1.085. That equals $101,990. "In effect, each year you are giving yourself a cost-of-living-adjustment (COLA) so your withdrawals keep up with inflation."
But what if your gut tells you that taking such a large chunk from your retirement savings is unwise? What if your instincts say such a large withdrawal endangers your nest egg's ability to last 30 years, which is what the 4.7% Rule calls for?
Obey Your Gut Instincts
Many financial advisors say: Obey your instincts. When the market has taken a big bite from your retirement savings balance, pare your withdrawal rate, says Kevin Chancellor, a financial advisor with Black Lab Financial Services.
Exactly how much to pare depends on each retiree's unique needs and circumstances. But in general a retiree might trim their withdrawal rate to 4% instead of 4.7% from their principal nest egg in a down market, roaring inflation environment, Chancellor says.
If they still need more cash for living expenses, they can pull that from their cash reserve. If a retiree has a cash reserve, it's separate from their main nest egg. And it should consist of one year's annual income, Chancellor recommends.
Let Inflation Subside
In Chancellor's hypothetical scenario, the total nest egg holds $500,000 instead of $2 million. But for the sake of education, only the percentages matter, not the dollar amounts. "If the client's portfolio went from $500,000 to $425,000 (because of the market's decline), I would only have them withdraw $17,000, or 4%, in income from the reduced retirement assets," Chancellor said. "(I would have them) pull the remaining $3,000 from other sources, such as cash reserves, if they absolutely needed it."
If you don't have a cash reserve in addition to your main retirement nest egg? Same solution: cut your annual withdrawal. Suppose you normally withdraw 4% a year. "If your portfolio is down 15% (this year), I might suggest taking out 3.5%," Chancellor said.
In future years when the market is healthier? When inflation is tamer? Feel free to withdraw more than 4%, he says. That leaves extra money inside your savings. And that leave more money in your account to grow when the market rebounds. "This helps you capture gains while keeping an average of 4% over the life of the portfolio."
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and actively run portfolios that consistently outperform.
