What does the 4% withdrawal rule mean?August 28, 2012: 6:30 AM ET
Could you clarify the "4% withdrawal rule"? Does it mean that if I have $100,000 invested in bond funds, income funds, and such, I can count on it to generate an income of $4,000 annually, leaving the principal intact? — Sam G.
Financial planners use the 4% withdrawal rule to estimate how big your nest egg should to be to meet your income needs in retirement. The rule as it's generally understood holds that you'll have an excellent chance of supporting a 30-year retirement with a portfolio that mixes stocks and bonds if you withdraw 4% of your assets your first retired year, then adjust for inflation in subsequent years.
It's a good rule of thumb — but it doesn't always work, warns Brian Pon of Financial Connections in Corte Madera, Calif. He notes that the 4% rule is based on a range of historical returns, and there's no guarantee that stocks and bonds will perform as well in the future as they have in the past. The more bearish the market is in the first years you withdraw money, the worse are your chances of success.
Rather than rely on the 4% rule, says Pon, be prepared to withdraw less in years after the market drops.
— Austin Kilham
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