The 4% rule is a retirement guideline suggesting that you can withdraw 4% of your retirement portfolio annually in the first year of retirement. You can then adjust that withdrawal by inflation each subsequent year, and still reasonably expect your savings to last for at least 30 years.
It’s a very simple way to calculate a sustainable withdrawal rate from your retirement investments in future years. It’s used as an idea of how long your money should last you moving forwards.
How did this investment rule come about ?
Its founder, William Bengen, used historical data from 1926 up to 1995. Which included past market performance and the effect of financial crises to try and create an easy-to-follow rule of thumb for retirees.
Its benefits are that it is considered straightforward and easy to understand. Along with a simplifed number or equation that is manageable and people can relate to. However, some investment experts think that is is to simplified and should be linked to a much more dynamic risk based approach is required.
Does this simple rule cover inflation ?
The calculation has included an adjustment amount to cover future inflation. On the basis that it ensures the future buying and purchasing power remains constant in line with any annual withdrawals.
The 4% rule is normally based on a portfolio comprising of stocks, shares and bonds.
While the rule of 4% can be used as basis or starting point to combat future events and withdrawals taken form your portfolio. It isn’t guaranteed or set in stone, it should include wider factors should as an individuals spending behaviours, attitude to risk. Plus what types of assets or investments they hold. External factors such as monetary policies set by governments, stocks markets fluctations etc.
As highlighted in recent times, the markets have seen great volatility through major events. Such as the tech bubble, housing crash in 2008, Covid pandemic starting in late 2019, Russia / Ukraine conflict staring in 2022.
So how does the rule of 4% actually work ?
In your 1st year of accessing funds in retirement, you supposedly withdraw 4% of the total portfolio value. Then in subsequent years, you take the same 4%, allowing for updated pot size and current valuation, adjusted for so-called inflation.
By doing this, it should allow you to keep in line and pace with the current rate of inflation. By doing so, your portfolio won’t be emptied or reduced too quickly.
The rule assumes that your portfolio should be diversified across numerous sectors and different assets. So a downturn in any particular class of assets, won’t have an adverse or detrimental affect on your overall portfolio. By doing this preferred option, your withdrawals should be taken from dividends received, and expected investment returns.
We all know your portfolio will have positive returns and negative returns in future years. Some external factors are outside your control. But you should aim to work with the market and not fight against it.
Are there any downsides to this rule ?
The 4% rule is considered to rigid or conservative by some, and it isn’t appropriate for all investors. It may be that you only have a small portfolio and the amount of 4% may not cover your lifestyle, bills, or current spending habits that you may have been accustomed to whilst working.
It may be beneficial to avoid any major purchases in the early years. As it many dramatically reduce the size of you investments held within the portfolio. Which could affect the later years, or it could be emptied much more quickly. The 4% rule works best, it you stick to a set amount each year. The amount can then be flexible based upon your future needs.
Can I solely rely on the 4% rule ?
The main factor may be at what age do you start accessing your funds or retirement account. At present the minimum pension age (MPA) in the UK is 55. Unless you have ill-health or protected age, and under current government proposals it will increase to age 57 from April 2028.
A study by Morningstar undertaken in 2022, highlighted that 3.3% is considered a safe-haven for the amount of income taken in drawdown. Over any period of prolonged timeframe.
It was based on the assumption that you portfolio is 50/50 or 60/40 in weighting across stocks / bonds. What is considered as a balanced portfolio.
You may also have other assets that you can access, or you may have eater forms of income, such as a Defined Benefits pension scheme (with gives a guaranteed level of income) plus your state pension. Which is set by the UK government based upon your NI record and contributions, currently payable from age 66. Although this will increase to age 67 between 2026 to 2028.
Another factor may be the current state of the economy when you do start disinvesting some of your funds. If the market if suffering a downturn or period of poor performance. You may decide to put any decisions on hold, or access on a reduced or drip feed method.
So when should I access or retire ?
This may be your main driver or biggest investment decision that you make. It will depend on your health current employment, for you and your spouse (if applicable). Do your goals, aims and objectives align with other family members.
It may be that you want to go travelling in the earlier years of your retirement whilst you are fit and healthy. Before you are too old, to go on long-haul flights, or unable to get required holiday insurance. It may be an idea to retire gradually so on some kind of phased basis, so you may go down to 4 days per week, then 3 days etc. Instead of making a life changing decision at once or on a whim. Most employers may show some kind of flexibility, as part of your retirement plans so sit down and consult with them.
It may not make sense to delay your retirement for an additional year, but play around the the tools and calculators on offer by your providers. Ahead of making any drastic decisions.
Obviously, the later you access your pot the shorter it will also you, and it may give you a higher level of income for when you do decide to access
Try this free pension calculator tools on the impartial Moneyhelper.org.uk website
What else should I consider ?
Your plan needs to fit in your aims, plans during retirement. How do you see yourself spending that free time.
Will you spend the early years travelling, so you may increase costs due to taking more holidays.
Will you partake in new leisure activities, such as golf, sailing, walking etc.
Do you plan to spend more time socialising with friends, family or new clubs you may join.
Or do you plan on a more relaxed lifestyle, or it could be minding the grandchildren proving free child-care.
What about your attitude to investments and your risk tolerance. It may well be much difference to the stages when you were trying to accumulate wealth. How would you feel it the markets lost value in the short term.
Plus are you happy managing your own investments, or do you want to pay an adviser to manage and control them on your behalf.
Are you happy handing over your investments to a 3rd party to control on your behalf.
The world of investing and your pensions horizon, should be seen as a long term investment. As somebody who retires in the 60’s may live to age 90, so nearly 30 years. At present average life expectancy in the UK is until the mid 80’s.
As they say a short term gain may lead to long term pain !
Have you done any budget planning or retirement calculations ?
When getting plan in place, it will be very worthwhile and beneficial if you create a simple budget planner. To give you an idea of what level of income you may need in the years to come. So list your essentials should as home, shelter, food, utilities. Then factor in needs and wants such as car or travel, eating out, socialising, holidays and travel, entertainment or sporting events.
It’s essential to have some kind of idea about how much money you will need realistically, and this will determine the level of retirement that you sustain.
Stay flexible – there may be some unexplained events ?
Everything that you envisage or factor in as part of your plan won’t go according to the rules. There will be some unforeseen events, as life cannot be predicted. It may be developing ill health or medical conditions, it may be unforeseen home repairs, needing a new car unexpectedly.
What if you circumstances change for you or immediate family members and they may need some money form you.
Is part of your plans creating a legacy or inheritance to immediate family members. Have you made some provisions for the family in future, if you are no longer here.
Ultimately, some things are out of your remit and you are unable to control, the aim is to have the best retirement plan that you can have. So above all, try and enjoy it, you worked long and hard to get to this stage in your later years.
Remember !
If you like this blog post, check out my other posts on https://moneyminted.co.uk, which covers savings, investing, pensions and investment books that I recommend reading. So you can improve your investing knowledge, financial education, so you too can reach your financial goals in future.
It’s not a get rich quick scheme but you will get there in the end if you create and action plan and think long term,
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