The 7% Rule: How Much Can You Spend in Retirement?

The average American has about $141,542 in savings for retirement planning.

However, in reality, most people have much less in their retirement savings account, given that the median balance in 401(k) plans is just $35,345. 

While you might not have control of the mitigating factors that influence how much you save, you can control what you spend in retirement to achieve your dreams if you get in touch with a reputable financial advisor in Portland today. 

Some of the most heralded expert rules of thumb for retirement that you’ll learn about include the 4% and 7% withdrawal strategies. But how do these rules work, and what are the steps for calculating retirement withdrawals? Find out more in this guide. 

What is the 7% Rule for Retirement? 

The 7% rule for retirement offers one of the highest annual withdrawal rates of your initial portfolio value, especially in a market with a low-price-to-earnings ratio. 

Besides fostering financial independence or well-being post-retirement, this rule is also applicable when gauging future, long-term returns of stock investments, preferably in 15+ year cycles. 

calculating retirement withdrawals

Let’s look into a real-life example of the 7% retirement rule strategy to put it into a better perspective. Assuming that you have $100,00 in your retirement savings account, you should withdraw 7%, which is $7,000 every year. 

Suppose the market gets volatile in the future, and your portfolio value falls to $82,000; the $7,000 withdrawal limit will represent 8.5% of your present portfolio value. 

Going Beyond the 4%: Things to Consider 

Spending too much or too little isn’t an option for retirees who want to enjoy their golden years in peace with full financial independence. 

One of the strategies that many people follow to make this a reality is the 4% rule in retirement — add your entire investment portfolio and withdraw 4% from it in the first year of retirement. 

Although the 4% investment rule can help determine how much you’ll spend in retirement without running out of cash, it will help if you explore beyond this strategy with a professional wealth management firm. 

With this approach, you’ll be able to calculate safe withdrawal rates in retirement to complement your spending habits. That said, here is what you need to consider if you’re applying this strategy.

How Long Are You Planning For?

Obviously, no one knows how long they’ll live, but you can gauge your life expectancy. For instance, you can compare your current health status with data trends from the Social Security Administration or family history to get a general idea. 

safe withdrawal rate

You might also want to factor in your risk tolerance for outliving your assets or accessing other resources like pension if the drawdown rate of your portfolio gets out of hand. 

What Are Your Investment Portfolio Options?

Ideally, your investment portfolio should be diversified to complement a sustainable optimal withdrawal strategy. You might want to look beyond asset allocation unless you're going to take a long-term, conservative approach. Cash and bonds can help you attain financial stability and pay recurring bills if you’re planning for early retirement. Stocks, on the other hand, can help you grow your wealth. 

Even with this, getting the right mix is about more than mathematical figures. It will help if you also talk to a professional retirement planning advisor for assistance in evaluating your options. 

Are You Confident About the Plan?

You can estimate if your investment will last by gauging your confidence levels. In this context, confidence levels represent the percentage of times when a hypothetical investment portfolio didn't run out of cash. 

For example, having a 90% confidence level means that you’ve forecasted 1,000 scenarios based on the historical rate of return for bonds and stocks and determined that 900 portfolios had money in them after the period. A higher confidence level will make retirement money last because you’ll be spending less. 

Do You Anticipate Future Changes?

The 4% percent rule in retirement assumes that your spending will increase throughout due to inflation, which is highly unlikely. It makes sense to cut down unnecessary expenses during down markets, such as a vacation. 

This will make your money last, especially if your savings by age 55 didn’t accumulate that much. At the same time, you might also need to adjust your investment options to match the foregoing market trends. 

Does the 4% Rule Still Work? 

The principles of the 4% retirement rule still work and can help you determine how much you will spend in retirement. However, it’s not a one size fits all for every retirement situation. Also, the retirement 4% rule needs modernizing to overcome its current limitations, which include:

  • Rigidity: As noted earlier, one of the biggest shortcomings of this rule is that it assumes your expenditure in retirement keeps growing. It also doesn’t consider that you might incur more expenses in some years, the foregoing inflation rates notwithstanding. 
  • 30-year horizon assumption: the Social Security Administration estimates that most retirees are unlikely to live past 30 years if they turn 65 today. In other words, the planning time horizon for people varies, depending on several factors, but this rule doesn't take that into account. 
  • Historical market returns: Yield projection for stocks and bonds using historical market returns can be inaccurate, thanks to the ever-dynamic market trends. Inaccurate estimations might translate to high retirement account withdrawal rates in the future. 
  • Mostly hypothetical: the rule applies to a retirement portfolio that constitutes 50% bonds and 50% stocks, which is quite hypothetical given that an ideal portfolio should be diversified on a wide range of asset classes. Moreover, minimizing exposure to stocks while transitioning into retirement is prudent. 

The 4% Rule or the 7% Rule: Which One Should You Choose?

Both the 4% and 7% retirement rules are applicable in real life, depending on your spending flexibility or longevity risk aversion. 

Individuals who are less flexible and depict greater longevity-risk aversion might want to slow down on their spending during retirement. The 4% rule might be applicable for these people and is deemed a safe withdrawal rate, given that it assumes higher stocks and bonds yield.

optimal withdrawal strategy for retirement income portfolios

On the other hand, some people can tolerate high failure risks or probabilities in the future because they don't anticipate living beyond their life expectancies. 

If you're under this category, you might want to implement the 7% rule in retirement as it gives you higher withdrawal rates. Whichever option you pick, seek professional retirement tax planning advice to determine whether it serves your goals. 

Why You Need to Rethink Your Withdrawal Strategy 

Various rules of thumb for investment are meant to ease the process of understanding and planning for retirement. But, in the real sense, the rule should be readjusted according to the retirement situation at hand. That's why it's imperative to rethink your dynamic withdrawal strategy, especially if you’re going to outlive your money. 

Other reasons that should prompt you to rethink your withdrawal strategy include

Inflation: Your retirement spend-down rates should match the foregoing inflation if you want the money to last. This means withdrawing the earnings of your savings over and above the inflation rate. For instance, you should withdraw 2% if you earn 8% from your savings, and the foregoing inflation rate is 6%  

Income drawdown: Higher income drawdown rates can be achieved by leaving your money invested in pension funds instead of buying an annuity. This can help you outlive your money or pass it to beneficiaries. 

Health costs: The recommended withdrawal retirement rate for individuals with underlying health conditions should be flexible to accommodate fluctuating annual medical costs. 

Availability of additional resources: Retirees with other resources besides their savings account, such as the social security fund or an income-generating business can have generally higher withdrawal rates that are sustainable. 

Calculating Your Safe and Optimal Withdrawal Rate 

A safe retirement withdrawal rate by age 65 and above should follow the 4% rule. While this rule doesn’t guarantee that your money will last throughout retirement, it limits how much you can withdraw, enabling your portfolio to withstand market volatility. 

That said, here is the formula for SWR retirement calculation:

Safe withdrawal rate (SWR) = (annual withdrawal amount ÷ total savings)

You can use this formula to find a withdrawal rate that sustains comfortable living and ensures that your money lasts for the longest time possible. Assuming you have $800,000 in 401(k) saving and your annual withdrawal projection is $35,000 —using the above formula, your safe 401k withdrawal rate will be:

SWR = (35,000 ÷ 800,00)= 4.3%

However, if you need more money from your retirement income portfolios, say $45,000 instead of $35,000, but still want to abide by the 4% rule, you would want to save beyond $800,000. To get an estimate of how much you’ll need in retirement savings, rearrange the formula this way:

Annual withdrawal amount ÷ SWR = total savings 

45,000 ÷ 0.04 = 1,125,000

This means you’ll need an additional $325,000 above your initial $800,000 target. However, calculations alone aren’t enough. Get in touch with an IRA retirement planning expert for more advice on how much you should withdraw from 401k annually. 

The Final Word 

Managing retirement savings can be quite an arduous, if not a balancing act. You don't want to spend too much for fear of running out of money while still on retirement. 

At the same time, lower withdrawal limits for retirement means you might not explore your golden years to the fullest or even miss vacations, yet it's your hard-earned money in question. Experts at Interactive Wealth Advisors can help you become a successful retiree through thoughtful planning. Whether you're facing a large windfall or an uninvited misfortune, our team will give you conflict-free advice on how to handle the situation and manage your wealth thereafter prudently. Contact us today to get started.

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