4% rule

The $1000 Rule and the 4% Rule

How much money will you need in retirement? How much income will you need each year? As you approach retirement, you will want to evaluate your options when it comes to income sources. You will receive income from Social Security benefits, as well as possibly retirement account distributions or a pension. One popular strategy for determining how much money you will need is the “$1,000 per month” rule.

This rule states that for every $240,000 that you set aside, you can receive $1,000 per-month, assuming you withdraw 5% of your savings each year. So, you’ll need at least $240,000 if you plan to withdraw 5% of your savings each year. If you’re planning on taking out $2,000 every month, at a withdrawal rate of 5%, you’ll need to set aside $480,000. For $3,000 each month, you should aim to save $720,000. Following through on this strategy involves developing passive sources of income: Your income could come from investments, rental properties, dividends, or other sources that require no active effort from you.

Advantages of the $1000 Rule

The more money you have access to in retirement, the better, especially in times of rising costs and high inflation. With this tactic, you can take some comfort in knowing what to expect: If you retire at age 65 with a $480,000 nest-egg, you can set up your monthly budget based on consistently withdrawing $2,000 monthly. You may even be motivated to save up more to receive a higher level of passive income. This rule does, however, have some limitations. Reliance on investments will expose you to risk; your portfolio balance will rise and fall with the market. In the event of a stock market downturn, your portfolio balance could drop, and when your retirement arrives you might not have enough money to last you using the $1,000 strategy. You may want to take out less than 5% each year in order to ensure your savings actually last. 

The 4% Rule

The $1,000 per-month is actually a variation of the 4% rule. The 4% rule has been a rule of thumb within financial planning for many years. The rule states that retirees can deduct 4% of their portfolio (adjusted for inflation) each year, and not run out of money for at least 30 years, assuming their portfolio is a 50/50 mix of stocks and bonds. Like the $1,000 rule, however, this strategy has some limitations. Not all retirees want a 50/50 mix of stocks and bonds in retirement. Furthermore, some people might need less or more money in a given year, making it impractical. These rules are meant to be guidelines, intended to ensure you save up enough for retirement and don’t withdraw funds too quickly. 

The 4% rule was an indisputable rule of thumb for a long, long time. But in recent years, this changed. Many financial advisors would’ve told you you’d likely run out of money by starting with that rate. Based on the state of the economy a few years ago, the recommendation was lowered to only 3.3%. However, very recently, we have some good news… 

The 4% Rule Is Back? 

Very recently, thanks to higher interest rates, it may once again be safe to employ the 4% rule. Spending 4% of savings in your first year of retirement (and then adjusting for inflation in subsequent years) may be advantageous for new retirees. An individual who retires this year with a $1 million portfolio with 40% of it in stocks and 60% in bonds would spend no more than $40,000 from their portfolio in 2024. Assuming inflation rises by 3% in 2024, that investor would then give themselves a raise, withdrawing $41,200 in 2025, regardless of the state of the market. For those already retired, however, it’s best to stick with the withdrawal amount they began their retirement with, adjusted for inflation, rather than switching to 4% now. 

Reach Out to Us

Investing in the stock market is a delicate process. The performance of a stock will change over time. And when you have time on your side, this is great. But as you get closer to retirement, preventing risk becomes more important; you’re going to need that income soon. If you’re looking to prevent losses as much as possible, it’s vital that you do your research and invest in the right stocks at the right times.

If you need help with this, it would be best to work with a qualified financial advisor with an “active” money management approach. Retallick Financial Group may be able to help with this. Reach out to us! You could reserve a spot at one of our educational dinner seminars. At these events, we’ll discuss potentially helpful information regarding planning for retirement. Or, you could schedule a one-on-one meeting with us, where we can discuss your own personal retirement strategy and your financial future. 

Sources: U.S. News, Wall Street Journal, The Balance

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