The $1,000 Rule and the 4% Rule

How much money will you need to get by in retirement? How much income do you need to withdraw each year? As you approach retirement, you want to evaluate your options when it comes to income sources. You will receive income from Social Security benefits, as well as possibly retirement account distributions or a pension. The “$1,000 per month” rule is a popular strategy for determining how much money you will need.

The $1,000 per month rule states that for every $240,000 you set aside, you can receive $1,000 per month, assuming you withdraw your savings at a rate of 5% each year. So, with the $1,000 per month rule, you’ll need at least $240,000 if you plan to withdraw 5% of your savings each year. If you’re planning on withdrawing $2,000 every month, at a withdrawal rate of 5%, you’ll need to set aside $480,000. For $3,000, you should aim to save at least $720,000. Following through on this involves developing passive sources of income. Your income could come from investments, dividends, rental properties, or other sources that require no active effort from you… For example, a fixed indexed annuity.

Advantages of the $1,000 Rule

The more money you have access to in retirement, the better. This is especially true in times of rising costs and high inflation. And, with the $1,000 per month strategy, you can take some comfort in knowing what to expect. If you retire at age 65 with a nest egg of $480,000, you can set up your monthly budget based on withdrawing $2,000 each month. You may even be motivated to save more to receive a higher level of passive income during retirement. This strategy does, however, have its limitations.

Reliance on investments will expose you to risk. Your portfolio balance will rise and fall with the market. In the event of a stock market downturn, your portfolio balance could drop, and when your retirement arrives you might not have enough money to last you using the $1,000 strategy. So, you may want to take out less than 5% each year in order to ensure your savings actually last.

The 4% Rule

The $1,000 per month rule is a variation on the 4% rule, which has been a financial planning rule of thumb for many, many years. This rule states that retirees can deduct 4% from their portfolio each year (adjusted for inflation) and not run out of money for at least 30 years, assuming their portfolio is a 50-50 mix of stocks and bonds. Like the $1,000 rule, however, this tactic has some limitations. Not all retirees want a mix of 50% stocks and 50% bonds. Additionally, some people may need more or less money in a given year, making this rule less practical. These rules are guidelines, intended to ensure that you save up enough money for retirement and don’t withdraw funds too quickly.

The 4% rule was an indisputable rule of thumb for a long time. But in recent years, this changed. Many financial advisors would’ve told you you’d likely run out of money by starting with this rate. Based on the state of the economy a few years ago, the recommendation was lowered to only 3.3% by Morningstar. However, as of very recently, we have some good news…

The 4% Rule is Back

Very recently, thanks to higher interest rates, it may once again be safe to employ the 4% rule. Spending 4% of savings in your first year of retirement (adjusted for inflation in subsequent years) may be advantageous for new retirees. An individual who retires this year with a $1 million portfolio, with 40% of it in stocks and 60% in bonds, would spend no more than $40,000 from their portfolio in 2024. Assuming inflation rises by 3% in 2024, that investor would then give themselves a raise, withdrawing $41,200 in 2025, regardless of the state of the stock market. For those already retired, however, it’s most advantageous to stick with the withdrawal amount they began their retirement with (adjusted for inflation) rather than switching to 4% now.

We Can Help

As you approach retirement, protecting your money becomes more and more important. You may want to move more and more of your money from investments into “safe money” options as you get older–One guideline you can use for this is the “rule of 100.” The rule of 100 states that, the closer you get to age 100, the more of your money should be kept in places where it’ll be guaranteed safe. For example, if you’re 63 years old, at least 63% of your savings should be kept somewhere safe, while the remaining 37% can be invested. When you’re 65, 65% of it should be kept safe, and only 35% at max can be invested. You get the picture.

And, speaking of safe money options, we may have some recommendations for you you that you haven’t considered. If you’re looking for a place to keep a percentage of your money (or even all of it) where it’ll be kept safe, but still earn interest at a reasonable rate (over time) reach out to us. We may have some very useful information for you.

Sources: U.S. NewsWall Street JournalThe Balance

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