Financial Planner
The 4 Percent Rule is DeadI recently read an article that focused on a very popular retirement strategy. As I was reading it, I noticed some considerable pitfalls with it. For those not familiar with the 4 percent rule, here is the background on the subject:
The 4% Rule is a retirement withdrawal strategy that ensures you do not deplete your retirement savings during your Golden years. You simply withdrawal 4% of your retirement savings, and add in the percentage for inflation. This will provide you an 80-90% chance that the retirement funds will last a minimum of 30 years. This strategy sounds pretty easy to understand but is it really that fail proof? The 4 percent rule may work well if the retirement savings is still receiving a decent return and not getting pummeled in the early years. Below are two scenarios that will cause the 4 percent rule to fail. Sequence of ReturnsSequence of returns is the risk of a retirement portfolio receiving lower or negative returns early while withdrawals are being made. There can be two retirement savings accounts with the same average gain and savings amount but with a different sequence of return. The difference between the two can be disturbing.
Here is an example of a $500,000 retirement savings portfolio of a 65 year old retiree. The average gain is identical but the order is reversed in scenario B. Scenario A.
Scenario B.
Age 65
24%
-15%
Age 66
10%
14%
Age 67
-6%
-5%
Age 68
3%
8%
Age 69
8%
3%
Age 70
-5%
-6%
Age 71
14%
10%
Age 72
-15%
24%
Age 73
$888,176.96
$670,705.71
The difference is $217,470.29! Now imagine what this would look like if the retiree took a yearly distribution of 6.5% (4% plus 2.5% for inflation) or $32,500.16. It increases the likelihood that the retiree in scenario B will run out of money before 20 years. If the same retiree elected to withdrawal a higher amount, they would have a major financial problem.
Long Term Care scenarioIf a retiree is faced with a long term care (LTC) situation, we will have to review the cost of care. The average cost of care in Southern CA is approximately $94,000 per year. When someone is faced with this, that individual will pay for the needed care and will use their largest asset to pay for it. Taking 94k per year to pay for this will completely wipe out all savings in a matter of years. The 94k per year does not include the amount needed to retire if there is a spouse. If the ill retiree can get by with in- home health care, the cost will get reduced to approximately 40k per year. Both situations will deplete the retirement nest egg but at a different pace.
ConclusionThe two risks above are scenarios that could severely impact retirement. It certainly raises questions to a common retirement strategy. Every individual has their own comfort level with having funds directly in the market. We recommend having your retirement portfolio analyzed and placed under various stress test. That way you can decide what risk is acceptable and what areas you would like to mitigate. The report is provided and explained so you can decide if you would like to generate a strategy to avoid retirement dangers.
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A financial planner or personal financial planner is a professional who prepares financial plans for people. These financial plans often cover cash flow management, retirement planning, investment planning, financial risk management, insurance planning, tax planning, estate planning and business succession planning for business owners.
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