As you navigate your journey through mid life job loss or career transition, there are undoubtedly many topics and concerns that are on your mind. My recent articles have discussed these matters, including your feelings about your career goals and whether you want to keep working! One of the key points I emphasize is that media portrayals of retirement seem to implicitly suggest that everyone wants to retire as soon as possible, when in reality that is often not true.
Financial Checkpoint Before Retirement
But one subject I have not yet written about is your financial “readiness” to stop working. Undoubtedly, this is a very important consideration, even if retirement might not occur in the immediate future. The time when you are in between jobs also happens to provide a great opportunity to review your situation!
Taking a comprehensive look at your finances will help you understand, among other things, whether you may stop working, either now (or at a later time if your preference is to keep working for the immediate future). In addition, a review may also influence your decision-making process about career-related matters, and many other financial and non-financial items as well.
That is not to say that money should necessarily be the sole driver in deciding whether you want to stop working. But it is surely important to fully understand your finances before you take the plunge!
Better to know soon that you have adequate resources to live a fully confident retirement (or alternatively what actions you may take so that you are financially prepared to leave the working world at a later time).
Can You Afford To Retire?
How do you go about evaluating whether you are financially ready to take that big step? For decades, financial professionals have used a number of guideline rules and calculations to help people plan and prepare for retirement. However, these conventional approaches and simplistic models may not always be a useful way to assess your financial preparedness to stop working.
For example, one of the most famous guidelines is called the “4% rule” for retirement withdrawals. Based on a well-known 1994 research article published in the Journal of Financial Planning, the author found that retirees can withdraw 4% of the value of their portfolio in the first year of retirement, and then annually increase the next year’s withdrawal amount based on the inflation rate.
Using this simple rule, this well known article (among wealth managers anyway!) concludes that most retirement portfolios would last at least 30 years, and perhaps as long as 50 years. Sounds reasonable so far, right? But, not so fast! In recent years, the 4% rule has come under attack by some financial professionals who think that this withdrawal rate is too high. I could write pages about the merits of both sides of this debate! But that would not be very helpful, especially because I think the debate is “much ado about nothing” (to quote William Shakespeare)!
Are Rules Made to Be Broken?
My opinion is based on years of experience in projecting retirement portfolio withdrawals and then monitoring those distributions over a long time period. That “real” world experience has taught me that the 4% rule is often not very useful or nor is it a practical way to approach financial planning.
That is because many retirements may last 25 years and sometimes longer. Over that timeframe, annual withdrawal amounts tend to vary significantly from year to year. In other words, in some of those years, you may need to withdraw more or less than the figure suggested by the 4% rule, depending on what is happening in your life.
Does this mean that your risk of running out of money will materially increase? Not necessarily! In my experience, I actually see this occur in most financial projections that I prepare and I do not think clients need to necessarily cut their spending to stay on track.
There are also certain account types which mandate withdrawals. For example, IRS rules require IRA account owners and 401(k) plan participants to withdraw money from those accounts beginning at age 72, with those mandatory withdrawal rates increasing in each successive year.
In fact, these required distributions will actually exceed 4% for most of your retirement years, unless you die very soon after age 72. Once again, one could read the 4% rule and come away thinking these IRS rules may materially increase the risk of retirees running out of money!
That outcome, of course, is not necessarily very likely, depending on that person’s situation and on whether they spend the money withdrawn. On the other hand, I do not want to imply that retirees should not worry about annual withdrawals which are consistently higher than 4%. Such high withdrawal rates over the long-term may not be a good idea and could increase risks of a financial shortfall!
The problem with the 4% rule is not necessarily about whether the withdrawal approach is too aggressive or unsustainable. Instead, the issue is that this “rule” implicitly assumes that withdrawals are the same every year when in fact, that is often not the case over a long retirement timeframe.
Simple Approaches Are Insufficient!
These are just a few of the many examples of why the debate about the 4% rule may not be very useful! Like many other retirement and financial planning platitudes, the 4% rule is too simplistic.
This rule, and other retirement planning truisms like it, may have been applicable for people thinking about retirement 20 or 30 years ago. However, they often do not fit the contemporary needs of today’s mid life professionals who have been excellent savers and investors over the years and who may enjoy long lifespans.
Instead, I recommend an individualized approach that includes preparing a detailed forecast of the expected withdrawals that each retiree will need over time. Retirees are human beings with lifestyle goals, changing financial needs and other practical considerations. It is hard to understand one’s readiness for retirement without fully understanding all of these elements over the long term!
Once all of these needs and financial data are meticulously captured, you can project the expected withdrawals over many years. This kind of planning offers a far more empowering way for people to evaluate whether they may enjoy a financially confident retirement! In my next article, I will be writing about the key elements of this modern approach to financial planning. Before that next segment, I hope you stay well and enjoy the transition into the Fall season!
