How Much Money Can I Withdraw From My Retirement Account?
The 4% Rule
We often receive inquiries from individuals planning for their retirement and wondering about the amount they can withdraw from their 401(k) or other retirement plan assets upon retirement. According to statistics, the average retirement age in the United States is 61, while the average lifespan is 77 years. This suggests that if you assume you will live for the average lifespan of the typical U.S. citizen and retire at the average age, your retirement savings and social security will fund 20% of your life.
This is something to consider carefully and can prompt you to reevaluate your retirement savings plans.
This is where the 4% rule comes in - a popular guideline for retirement withdrawals that many wealth management advisors and financial advisors have used.
Simply put, the 4% rule states that individuals can withdraw 4% of their initial investment portfolio balance each year, adjusted for inflation, and have a high likelihood of making their money last for 30 years or more. For example, if you have $1 million in your portfolio, you can take $40,000 in the first year and adjust the amount for inflation in the following years.
While the 4% rule is not a guarantee, it is a good starting point for retirement planning. However, it is essential to note that the rule is based on certain assumptions, such as a balanced investment portfolio of equities and bonds and historical market returns. In reality, market fluctuations and unexpected expenses can impact the sustainability of your retirement income.
This is where a wealth management advisor or financial advisor can be beneficial. They can help you determine a withdrawal strategy that aligns with your goals while considering taxes, inflation, and healthcare costs. They can also help you adjust your plan if circumstances change, such as a market downturn or a significant life event.
In addition to working with an advisor, there are other steps you can take to help ensure a successful retirement. These include saving aggressively during your working years, diversifying your investments, and managing your expenses in retirement.
Monte Carlo Simulation
The Monte Carlo simulation is another tool wealth management and financial advisors may use to help clients plan for retirement. This method involves running thousands of simulations based on different market scenarios to determine the probability of success for a particular retirement plan.
Monte Carlo simulation considers factors such as portfolio allocation, expected returns, volatility, and other variables like inflation and taxes. Running multiple simulations can provide a more accurate picture of the potential outcomes of a retirement plan and help identify any potential risks or gaps that may need to be addressed.
For example, a Monte Carlo simulation may show that a retirement plan has a 90% probability of success, meaning there is a 10% chance that the plan may fail. In this case, an advisor may recommend adjustments to the plan, such as increasing savings, adjusting asset allocation, or considering other sources of income in retirement.
While Monte Carlo simulation can be a helpful tool in retirement planning, it is essential to remember that it is not a crystal ball and cannot predict the future. Market fluctuations and unexpected events can still impact the success of a retirement plan. However, by using Monte Carlo simulation and other retirement planning tools and strategies, advisors can help clients create a more comprehensive and realistic plan for their retirement years.
Sequence of Returns
Many popular financial entertainers host radio shows and TV shows about taking a significant percentage of your retirement savings annually and investing in riskier portfolios such as 100% stock.
Here's one of the significant issues with this thinking. The S&P 500 has an average yearly return of 10.04% if you look at 30 years ending December 2023. This assumes dividends are reinvested. These inflation-adjusted returns have yielded about 7.32% over these 30 years.
If you average out these returns, it paints a different picture than any given year in the stock market. For example, there are calendar years when the S&P 500 has ended above 30%. There are also calendar years where the S&P 500 has ended its calendar year in negative double digits. Even when you look at positive years, there are often intra-year declines in any given positive year.
The point we are trying to make is that you can have a robust positive average even when there are massive negative years. And the sequence of returns can be highly impactful as well.
Consider this. If the market took a 32% loss in a given calendar year and you took out 8% as an income that year, your portfolio would be down 40%. The question is, how much return would you need to make to offset that 40% difference in your portfolio value? Let's use an example to illustrate this point.
Let's say you have $1 million in your account. A 40% loss in your portfolio value would leave you with $600,000 in your account. How much would you need to gain in the market to offset the losses from your portfolio?
If you were to have a 40% gain in the market next year, that would provide $240,000 in gains.
$600,000 x 40% = $240,000
$600,000 + $240,000 = $840,000
In other words, your 40% loss and a subsequent 40% gain would leave you with $840,000, not back to the $1,000,000 you would have originally had. You must have made over 66% in the market to recover that loss.
$600,000 x 66.66% = $399,960
$600,000 + 399,960 = $999,960
If it were the case that the S&P 500 consistently did 10% every year, there may be a different picture than what we have just illustrated. The issue is that the sequence of returns, not just the average returns, is vital.
Conslusion
In conclusion, the 4% rule can be a helpful guideline for retirement withdrawals, but it is not a one-size-fits-all solution. Working with a wealth management or financial advisor can help you build a personalized plan, considering your unique circumstances and goals.
If you have questions regarding how much money you can take out of your retirement plan during retirement, please reach out to one of our Salt Lake City, Utah-based financial advisors.