Jun 4, 2024
You work your entire life to save money for your retirement. You'll obviously want to outlive those savings. However, at the same time, you don't want to live so frugally as a senior that you leave a lot of money behind and don't get to enjoy your retirement because of your penny-pinching.
To maximize the chances your money will last, while still giving you enough to live on, it's important to be strategic about your withdrawal rate. That's the rate at which you take funds out of retirement plans such as your 401(k) or IRA.
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For years, experts have touted the 4% rule which says your retirement savings should last 30 years if you withdraw only 4% of it in the first year and then adjust that amount each year after that to account for inflation. This is based on a balanced portfolio with a stock allocation of 50% to 75%. However, it has been called into question in recent years, with some arguing 4% is too much to take out and others suggesting it's too little.
While the idea of withdrawing 6% may seem attractive, the important question is whether it's really sustainable in the end.
What a 6% rule could mean for your retirement
U.S. adults believe they need $1.46 million in savings to retire comfortably, but many will struggle to achieve that.
A switch to the 6% rule could provide much-needed financial relief. For example, for a new retiree with savings of $500,000, withdrawing 6% instead of 4% would provide an extra $10,000.
Unfortunately, the reality is that such a high withdrawal rate significantly increases the chances of your account running dry.
Morningstar’s annual study says the highest safe withdrawal percentage — assuming a balanced portfolio, fixed real withdrawals over a 30-year retirement, and a 90% probability of success — is 4%. It adds that retirees can enjoy even higher starting withdrawals, “assuming they’re willing to accept other trade-offs, such as fluctuating year-to-year real cash flows and the possibility of fewer leftover assets at the end of a 30-year period.”
However, a very aggressive portfolio has a higher probability of lasting three decades with a 6% rule than a balanced one.
One 1999 study from the Association for Financial Counseling and Planning Education using data from 1926 to 1997 revealed that portfolios of 100% stocks provide a 65% chance of lasting for 30 years with 6% inflation-adjusted withdrawals.
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Newer research using data from 1926 to 2014 came to the same conclusion for a portfolio with 100% stocks.
Similarly, a recent analysis from Capital Investment Advisors cited by Forbes found that “the probability of a portfolio subsisting for more than 30 years at a 6% withdrawal rate goes up, not down, with a 100% stock allocation, jumping to 72%. The money endured more than 30 years 72% of the time, while 69% of the time, it lasted more than 35 years. Compare this to the balanced (60% stock, 40% bond) portfolio, where the money only survived 35 years or more 51% of the time.”
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Should you take a chance on a stock heavy portfolio?
If you're considering adopting the 6% rule, it's important to understand the added risk you're taking on.
Traditionally, retirees aim to limit their exposure to the fluctuations of the stock market by devoting only a percentage of their portfolio to equities (often calculated by subtracting their age from 110 or from 100).
The rationale behind this advice is sound. The market can and does have downturns. If you're 100% invested in the market, you may need to withdraw a significant amount of your money to live on even during a market slump, which would mean selling low and missing out on the chance for a stock price rebound.
Investing 75% or 100% of your retirement funds in the market could give you the returns to make the 6% rule work. Unfortunately, if you got unlucky with your timing, it could also leave you broke. If that happens, you can't go back and undo what you've done, nor can you easily return to work to make up for any shortfalls after being retired for a while.
Before deciding to risk it all in the market in hopes of being able to sustain a withdrawal rate that's much higher than the standard recommendation, think seriously about whether the very serious potential downside is worth it.
A better approach may be to save more throughout your life so following the 4% rule can still offer you the income you need to have the retirement you deserve.
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Christy Bieber has 15 years of experience as a personal finance and legal writer. She has written for many publications including Forbes, Kilplinger, CNN, WSJ, Credit Karma, Insurify and more.
