How long will my retirement savings last Understanding the 4% rule

How long will my retirement savings last Understanding the 4% ruleHow long will my retirement savings last Understanding the 4% ruleTrying to figure out how much you should save for retirement or how long your savings will last? In todays post, we are going to look at the 4% rule and how to use it to determine how much you should be saving or if you areready for retirement.Follow Ladders on FlipboardFollow Ladders magazines on Flipboard covering Happiness, Productivity, Job Satisfaction, Neuroscience, and moraWhat is the 4% rule?When it comes to saving for retirement, it seems there are a ton of rules to understand. Every financial professional has adifferent perspectiveon what you need to do in bestellung to thrive in retirement or how long your retirement savings will last. It can be confusing to sort through all the data at your disposal and identify how much you must save to retire.Many financial professionals, bloggers, and money experts recommend using the 4% rule. It may sound simple to understand but lets take a deeper dive.The history of the 4% ruleIn the early 1990s, financial plannerWilliam Bengencan up with the 4% rule. He tested a variety of withdrawal rates on several different portfolio allocations using return and inflation data back to 1926. He discovered that the ultimate withdrawal rate would be 4% assuming a 30-year term.He established that each retiree would take 4% their first year and then adjust for inflation in the years remaining.Many people assume that with the 4% rule you withdrawal 4% of your total portfolio value each and every year in retirement. This isnt the case. Your first year in retirement you will withdrawal 4% and then adjust for inflation every year after that.For example, lets say you have a portfolio of $1 million and inflation is 2%. Upon your first year of retirement, you would take out $40,000. Then your second year you would take out $40,800. Then your third year you would take out $41,600 and so on.Keep in mind, th e 4% rule doesnt guarantee you wont run out of money or that your retirement savings will last. However, if you stick to a pre-determined withdrawal amount, it can provide a level of confidence that your portfolio will support you at least 30 years.How dividends and taxes play a role in the 4% ruleThe other two factors worth mentioning are taxes and dividends. Many retirees assume they should take their dividends as well as 4%. This is incorrect. Retirees should factor in their dividends into their 4%. If we use the example above, and you received $15,000 in dividends in your first year of retirement, you should only distribute anotlageher $25,000.The same goes for your taxes. You should still only distribute 4% of your total portfolio and pay the taxes on that sum. Lets say your federal tax rate was 24%, you would then need to withdrawal $52,600 to account for taxes. This would mean that your withdrawal rate would be 5.3%. This percentage might not allow you to maintain your portfo lio for the longevity of your life.How much should I have saved for retirement?The four percent rule is a popular formula for figuring out how much you should save for retirement. Lets say for example you wish to retire on 40K a year income from your savings, then you would need to save 1 million dollars. (Easy enough, Right?)Tip An easy way to determine how much you will need to save using the 4% rule is it to multiply your desired income by 25. I.e. 40k times 25 = $1,000,000.00Why 4%? Why not 5, 6, 7%The 4% rule was determined to have the highest probability of not running out of money based on historical market conditions. Even at just 4%, the rule doesnt guarantee 100% success that savings will last, because of this academics debate the validity of the 4% rule.Some believe the 4% rule is too conservative, while others like Ibbotson believe the 4% rule should be revised to a lower withdraw rate to adjust for todays lower interest rates.Why the disagreement?No one knows for certai n what type of returns a retiree will experience. A retire who retires when stock valuations are low may experience above-average returns in retirement and may be afforded the opportunity to take much higher withdrawals.The retiree who retirees at the peak of the market, may be more inclined to experience a market downturn or low growth in retirement, and may find even modest withdrawals deplete their nest egg.The 4% rule doesnt work for everyoneMichael Finke, Ph.D., CFP Wade D. Pfau, Ph.D., CFA and David M. Blanchett, CFP, CFAsuggest that retirees may want to aim for a 3% rule. However, even with this rule, there is a 20% failure rate.On the other hand,Michael Kitceshighlights that since the late 1800s that bond yields may have been low but stocks performed horribly. Yet, he still notes that if a retiree uses the 4% rule with a portfolio invested in 60% stocks and 40% bonds, they would end up with double the amount they started with after 30 years.So, whats the point? Its impossibl e to predict the market and future returns. This makes it even more unlikely that you can predict your withdrawal rate.Making your retirement savings lastListening to experts who disagree can make you feel hopeless. If you must save over a million dollars just to earn a modest income, an eventual retirement may seem unattainable.However, all is not lost you may not need to save as much for retirement as the calculators suggest. You just have to be more efficient with your money.Consider a tax plan to minimize taxes in retirement. Every dollar you can avoid in taxes is less money that needs to be withdrawn from your portfolio.Consider the best timing of Social Security benefits. Contrary to popular opinion waiting to 70 may not be the best plan.Invest in ways to reduce costs and minimize expenses. Saving money is often times more efficient than trying to earn more money.Invest differently. Consider alternatives to bonds in the portfolio likeM.E.Cs and Fixed Indexed Annuities. These c ontracts have shown to generate higher returns than bonds with less drag on the portfolio when markets are rising.Diversify your income sources. Consider alternative ways to increase your income in retirement such as the numerousways to make moneyonline, or even a hobby farm or side business.Develop afinancial emergency preparedness plan. The most significant risk to your retirement is a financial emergency dictating that you withdraw funds are an inopportune time.The bottom lineWhether you decide to use the 4% rule or not, you need to determine a withdrawal rate thatwill work for you. Even if you dont know how your investments will perform, you need to make a plan for your retirement. The more prepared you are, the more likely your portfolio will last through your entire retirement.Evaluating all the aspects of your financial life will help you determine whats the right plan for you.This article was originally published on Your Money Geek.You might also enjoyNew neuroscience reveal s 4 rituals that will make you happyStrangers know your social class in the first seven words you say, study finds10 lessons from Benjamin Franklins daily schedule that will double your productivityThe worst mistakes you can make in an interview, according to 12 CEOs10 habits of mentally strong people