Thanks to historically low interest rates that are unlikely to rise any time soon, following the popular “4% rule” for retirement account withdrawals may deplete your savings. In the past, a 65-year-old who withdrew 4% in Year One plus an inflation adjustment thereafter had a 95% chance of sustaining a portfolio for 30 years. However, this is based on a historical average yield of 4% for five-year Treasuries. Their recent yield of just 0.4% cuts the probability of a 4% initial withdrawal rate lasting 30 years down to roughly 50%. That could force you to rely on guaranteed income alone (e.g., Social Security retirement benefits and/or a pension), which may not be enough to maintain your lifestyle.
What to do instead: Follow a 3% rule. First, create a portfolio split evenly between large-cap stocks, which have historically returned about 10% per year, and five-year Treasuries. The first year that you start to make retirement withdrawals, take out 3% of the total value of your portfolio. From Year Two forward, withdraw the same amount as Year One plus an adjustment for inflation. Even using recent ultra-low Treasury yields, a 65-year-old following this strategy for 30 years has a 90% chance of not running out of money.
Example: With a $1 million 50/50 stock-and-Treasury portfolio, you withdraw $30,000
in Year One. In Year Two, if the inflation rate is 2%, you withdraw $30,000 plus $600 and so on.
For investors still saving for retirement, you’ll need a nest egg 25% larger than you might have planned if interest rates stay low. For those already retired, consider replacing some or all of the bond investments with an immediate annuity, which may guarantee more annual income than you could get using bonds.