Breaking the 4% Rule

You’ve probably heard of the so-called “4% rule,” which says you shouldn’t take more than 4% of your portfolio annually if you want it to potentially last for 30 years. And in some cases, some people have narrowed it down to somewhere around 2%–3%.

Here’s something you need to know: this 4% rule isn’t really a rule—it’s more of a guideline. And because rules and guidelines are sometimes meant to be broken, in certain instances you might be able to take more—maybe even a lot more—than 4%.

Here’s a hypothetical example. Let’s say we have a single individual who wants to retire at age 64. He has $750,000 saved up and needs $5,000 of monthly income. If he took his Social Security at 64, he’d get $2,300 per month. That means he would need $2,700 per month from the portfolio, or about a 4.4% distribution rate on the $750,000. That’s not bad and may be workable. 

But what if this individual expects to live a long time? In that case it might be better to wait until age 70 to take his Social Security. By waiting, his benefit could grow to $3,500 per month, meaning at that point he could take a lot less from the portfolio—just $1,500 per month. But in the meantime, for the next six years, he has to take a $5,000/month gross income, which is an 8% distribution from his $750,000 portfolio.

You might be thinking that 8% is unsustainable. And you know what? You’re right. It is unsustainable over a long period of time. But the man in the example is only taking it for the next six years. After that, his distribution rate could go down dramatically because Social Security should be providing well over half of his income needs.

What this allows our hypothetical individual to do is to take a higher distribution rate now, for just a few years, in exchange for what may be a much lower distribution rate and higher Social Security benefits for the rest of his life. And this is done by ignoring the 4% rule and taking a lot more, at least for the first six years of retirement.

Of course in order for this to work, this person’s assumed longevity would have to become a reality. Obviously, if he postpones Social Security until age 70 and uses up extra money in his portfolio to buy him the time only to then die at age 71 or 72, he made the wrong choice. In that scenario, he would get less in Social Security payments and his heirs would lose out on the money he used for income.

But this example demonstrates in real terms why you sometimes need to ignore what passes for common wisdom and just focus on your own goals instead.

Important Information:

Information presented should not be considered specific tax, legal, or investment advice. You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy (including the investments purchased and/or investment strategies devised by LCG) will be either suitable or profitable for a client's or prospective client's portfolio, thus, investments may result in a loss of principal. Accordingly, no client or prospective client should assume that the presentation (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from LCG or from any other investment professional.

Case studies are hypothetical, are for illustrative purposes only, are not guaranteed and subject to potential federal and state law amendments. There is no guarantee that you will achieve the results discussed.

The information provided is based on current laws, which are subject to change at any time. Lucia Capital Group is not affiliated with or endorsed by the Social Security Administration or any government agency.

Social Security rules can be complex. For more information about Social Security benefits, visit the SSA website at www.ssa.gov, or call (800) 772-1213 to speak with an SSA representative.

Rates of return are hypothetical, are for illustrative purposes only, are not guaranteed, and do not represent the performance of any one investment. There is no guarantee that you will achieve the results illustrated or that the investment strategy will meet its stated objectives.

Rick Plum is a registered representative of, and offers securities through, Lucia Securities, LLC, a registered broker/dealer, member FINRA/SIPC. Advisory services offered through Lucia Capital Group, a registered investment advisor, and an affiliate of Lucia Securities, LLC. Registration with the SEC does not imply a certain level of skill or training.

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