On Course For Regret? Avoid The 4% Trap And Other Retirement Mistakes
Most of us dream about retirement as our future “golden years.” Retirement is the time we want to relax, travel, spend more time with loved ones, and enjoy life to its fullest. But if approached poorly, those retirement years can end up looking a lot more like… well, how should we put this?
Not so golden.
Over the past century or so, economists and financial experts have developed data-driven strategies and guidelines that helped millions of Americans achieve the level of financial independence needed for a hypothetically secure and comfortable retirement.
But when economic landscapes change, as they inevitably do, some of those strategies and guidelines no longer work as effectively as they once did. Because the truth is, the economic landscape of the 21st century is much different from that of the 20th century. For example, young savers and pre-retirees today can no longer rely on as much support from Social Security to supplement their retirement savings, so they have to come up with new strategies to make up the difference.
Today, we’ll review the relevance and applicability of a popular nest egg withdrawal rule of thumb—The 4% Rule—as well as some of the modern-day implications of retirement that this traditional benchmark fails to fully address in the 21st century.
The Misleading 4% Rule
The 4% Rule is a withdrawal guideline for how much you can safely draw down your retirement accounts each year without the risk of running out of money in retirement. The rule is based on 50 years of data regarding the stock and bond markets between 1926 and 1976.
This data found that there was not a single instance where withdrawing 4% of a retirement nest egg annually would fully exhaust one’s retirement portfolio in less than 33 years. Put more simply, if you didn’t withdraw more than 4% of the principal a year for about 30 years or less, you wouldn’t outlive your money.
Like many rules of thumb, this guideline can be useful for establishing a general parameter for how much you need to save for retirement and why. But leaning too much into generalities can expose you to the technical and unexpected risks always present in matters of personal finance.
Not Accounting For Major Market Shifts
Obviously, a lot has changed in the economic landscape since the 1920s and 70s. These changes have impacted our technology, laws, social interactions, and society as we know it. And since stocks and bonds are always adapting to present market conditions, you better believe their return rates and yields have changed as well.
For example, let’s look at bonds. Between 1965 and 1975, 10-year U.S. treasury bonds were yielding returns between 4% and 9%. But jump to more recent years, and the yields aren’t even close. Between 2015 and 2020, yields rarely cracked 3% and even fell below 1%. So do traditional asset allocation recommendations for retirees still make sense given average bond performance today?
The point here is that traditional markets will shift dramatically, and their effects can linger for decades. Past trends can certainly help us predict the future, but it’s foolish to think they know the future. If traditional retirement savings strategies and portfolio allocations aren’t updated to reflect new market trends, retirees may suffer the consequences.
It’s also worth noting that The 4% Rule is based on averages for stocks and bonds. So depending on how well stocks can continue to pick up the slack, or bonds can bounce back, The 4% Rule will need some recalibrating with present-day market data.
In the financial markets, the only constant is change. Sectors of the economy are subject to huge fluctuations. So let’s talk about one particularly relevant to retirees…
Rising Healthcare Costs
The American healthcare system has had no shortage of associations with high costs. And there are a number of factors that can drive the increases. These factors include but are certainly not limited to government policies, inflation, population growth, and life expectancy. The culmination of these forces has led to the following startling facts:
Individual health insurance costs have been steadily increasing at a rate of about 4.5% annually for the last 5 years, a rate far above normal inflation rates.
COVID-19 has added a price spike of its own. Research published by Northwestern Mutual in 2021 found that 24% of Americans now plan to retire later than expected. One of the most cited reasons for this was rising healthcare costs and unexpected medical expenses.
Those with health insurance coverage provided through their employers saw average yearly premiums for family coverage rise a full 37% between 2015 and 2020.
Americans are paying higher out-of-pocket expenses than ever before. This is especially true for those with high deductible health plans (HDHPs).
Granted, this trend of growing healthcare costs is subject to change. But over the past 5 years, we’ve seen medical expenses outpacing inflation and showing few signs of stopping.
Relying on outdated data from The 4% Rule, coupled with the increased rise in healthcare costs most retirees will be on the hook for, means that retirees who do follow this guideline may be at risk for outliving their savings.
Underestimating Life Expectancy
It’s great to think of the long and healthy lives that may be ahead of us. And modern medical amenities have made a longer lifespan more likely than ever.
In fact, the average total life expectancy in the U.S. has risen nearly a decade from 69.7 to 79.4 years between 1960 and 2015. Projections show that the same figure could cross the 85-year mark before 2060. Additionally, the average ages for retirement for women and men are 62.3 and 64.6 respectively.
If you’re looking to retire early (as many are these days), increasing life expectancies will further require retirees to reevaluate their drawdown percentage strategy. The takeaway here is that The 4% Rule faces further strain when you consider ever-increasing lifespans after retirement as well as rising medical costs.
Besides, Can You Really Live Off Just 4%?
Finally, the fact remains that many people just aren’t able to save enough towards their retirement to where The 4% Rule makes much financial sense. Most experts recommend that you should expect to live on about 80% of your salary each year in retirement. So if you make $100,000 per year, you would need to save enough to have $80,000 per year in retirement.
Investors would need to save at least $1,000,000 to generate just $40,000 per year in retirement. If you want $80,000 a year, that’s a $2,000,000 nest egg. And if you want $150,000 a year, that’s about $3,800,000. Many individuals simply won’t be able to save that much—or they’ll have to live incredibly frugally for decades to do so.
Due to changing economic conditions, we think there’s a better way to save for retirement and generate the income you need to be comfortable.
Chicago Trust Administration Services Can Help
Preparation for retirement can be thrown off by the out-of-date 4% Rule. More recent trends and data have to be factored into your retirement savings and withdrawal strategies to truly ensure you won’t outlive your money. As we’ve seen with the bond market, radical market shifts can and do happen. Shifts may be temporary, or they may last for decades.
Furthermore, we must also consider changes in expenses relevant to those in retirement. For example, rising healthcare costs continue to be a pressing concern. Planning for those increased costs becomes paramount for all retirees as life expectancies increase.
At Chicago Trust Administration Services, we’ve devoted ourselves to helping investors build their nest eggs with more creative strategies through self-directed investing. By offering investors the tools they need to invest retirement savings in nontraditional assets like real estate and private equity, individuals and families can start to take advantage of new strategies to save for retirement.
Are you interested to learn more about how we administer self-directed IRAs to help investors adapt to the modern market? If so, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com. We look forward to sitting down with you to discuss your options for self-directed investments.