The 5% Rule is the new 4% Rule in Retirement

(US News) In 1994, financial advisor William Bengen established the 4% rule that stipulates you should be able to withdraw 4% of your retirement savings each year without running out of money during your lifetime.

But if you are a long-term investor who has maintained a diversified portfolio throughout your accumulation years, you might instead consider increasing your withdrawals to 5% each year.

Drawing down 5% will still maintain financial security and help you ride through any market cycle without overreaching, as your portfolio will be able to make up any losses that are incurred during a downturn when the markets recover.

Here are some key steps for an investor to take to determine whether to follow a 5% withdrawal rate in retirement:

  • Calculate how much you will need in retirement to draw down 5% each year.
  • Make sure you are not in debt.
  • If you don't have children or other beneficiaries and want to spend your hard-earned money, consider withdrawing more.

Calculate How Much Would Be Needed

A key step is to determine how much money you will need in retirement to draw down 5% each year.

If your intention is to preserve your assets to pass them down to your children or other beneficiaries in the future, withdrawing 5% each year will ensure a secure retirement so long as your nest egg is large enough to allow it.

During your accumulation years (or those prior to retirement) consider what lifestyle you will want to maintain in retirement and how much you will need each year to achieve it.

This would be the time to factor in travel plans, the future purchase of vacation homes, ongoing financial support of family members and any other significant expenses.

Proper financial planning throughout your life is required to ensure you have an adequate nest egg and that following the 5% percent rule will be effective.

Work with a trusted financial advisor who can help determine that your investment strategy can accumulate enough savings by the time you plan to retire to allow for a 5% distribution each year.

For example, if you conclude that you want to have $50,000 to spend each year, you will need to have $1 million dollars saved in order to retire.

On the other hand, if you have a retirement portfolio of $5 million, you can draw down $250,000 each year while still preserving your assets.

Make Sure You Are Not in Debt

To follow the 5% rule in retirement correctly, you cannot be carrying any debt.

If you have a mortgage, credit card, or any other debt that you need to pay off, those payments will eat into the 5% you're taking out each year and prohibit you from affording the lifestyle you determined you wanted to have.

Work with your financial advisor to make sure you are completely debt free before adhering to the 5% draw down rule.

Drawing Down More Money May Be An Option

If you don't have children or other beneficiaries and want to spend your hard-earned money, consider withdrawing more. Some people are adamant that they want to spend most of their money before they pass away, and then distribute whatever is left to their favorite charitable causes.

If you and your financial advisor agree that you truly have more than enough money to last for what is an increasingly long life expectancy in the United States, and you are not concerned about drawing down your portfolio's assets, you can consider increasing your annual withdrawal to 7% or even 8% based on your level of wealth, lifestyle and expenses.

Just be sure to have regular check-ins with your financial advisor to confirm you are not overspending and are still on track.

This strategy is not, however, recommended for people who want to pass on their estate to others or have other circumstances that would make 7% or 8% far too high of an annual distribution.

Whichever percentage you choose to withdraw from your retirement savings each year, it is critical to make the decision alongside a financial professional who knows your portfolio, lifestyle and estate plan.

A secure retirement strategy is most certainly always the best one.

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