The Income Plan
Plan Goals
It is prudent to set three standards for retirement income:
- The income should last for as long as you live,
- Its purchasing power should keep pace with the cost-of-living, and
- It should be protected against the damages that could be caused by bad investment experience.
These standards help retirees address the major risks to retirement income: longevity, inflation, and market volatility.
4% Withdrawal Rule
In order to produce retirement income that meets the three goals described above, financial planners have a "rule of thumb" for you to follow. It is called the "4% rule."
The 4% rule was first made popular by William Bengen, a financial planner. His research was first published in the Journal of Financial Planning in October 1994. It is his findings that are summarized on this page. See Retirement Research for the full Bengen article.
How it works: 4% + CPI
The 4% rule for retirement income says that annual withdrawals from your retirement assets should be no more than 4% of your retirement savings, in the first year, and thereafter should be increased only for the rate of inflation. This assumes you want the income plan to last about 30 years.
For example, the rule says if you have $100,000 in assets, the income that you should withdraw from that sum in the first year is limited to $4,000. If inflation is 3% at the end of that year, withdrawals in the second year of retirement would be limited to $4,120 ($4,000 plus 3%); if inflation is 5% in the second year, then withdrawals in the third year would be limited to $4,326 ($4120 plus 5%), etc.
Why only 4%?
You may think that 4% plus annual inflation is a very low withdrawal plan for retirement income. But economic studies have shown that it takes this "low" level of withdrawal to have a 90+% probability that your income will last for as long as you live. These same studies show that, for example, withdrawals under a rule of "5% plus inflation" would have a 40% chance of failure in a 30 year retirement! See the Retirement Research tab for these studies.
Many independent studies show that, once you retire, your assets are much more sensitive to market volatility and bad investment experience than they were while saving for retirement. For an explanation of why this is so, see the Sensitivity to Loss section.
Finally, economists have demonstrated that purchasing a fixed annuity can substantially increase the annual retirement income you can derive from your savings. To understand how a fixed annuity helps a retirement income plan, see Protecting Assets and Increasing Income.
Note: Information provided in the Planning Retirement Income tab is representative of the views of ELM Income Group® and not necessarily those of any member of the Principal Financial Group®.