Will the retirement 4% rule work for you?

Willie Grace | 11/11/2015, 9:04 a.m.
The 4% rule -- initially withdrawing 4% of retirement savings and then increasing that dollar amount annually by the inflation ...
“A lot of boomers had all of their retirement investments in the stock market and, if they didn’t lose their principal, it will take some time for them to recoup their gains,” says Jeff Bucher, a financial advisor who helps working-class Americans plan their golden years.

NEW YORK (CNNMoney) -- I'm in my mid-60s and plan to retire this year. I've heard that if you want your money to last 30 years you should follow the 4% rule. But how much can I safely withdraw if I need my money to last only 20 years? --John, Connecticut

The 4% rule -- initially withdrawing 4% of retirement savings and then increasing that dollar amount annually by the inflation rate -- has long been touted as the go-to strategy if you want a high level of assurance your nest egg will last at least 30 years. So it seems reasonable that if you need your savings to support you only 20 years, you should be able to start with a higher withdrawal rate -- say, 5% to 6% -- and have a comparable chance of your dough not running out.

But before you embark on any withdrawal strategy, you need to understand a couple of important caveats. First, unless you're really sure you're going to die within the next 20 years -- say, due to an already diagnosed fatal condition or life-shortening disease -- I don't think it makes sense to create a retirement income plan that assumes you'll live only into your mid-80s.

According to the most recent longevity figures from the Society of Actuaries, a 65-year-old man is expected to live on average another 21 to 22 years, and a 65-year-old woman is projected to live another 23 to 24 years. But that's on average. Roughly half will live longer than that, and many 65-year-olds will live much longer, well into their 90s.

If you spend down your savings by your mid-80s but live into your late 80s or 90s (or longer), those extra years of life you didn't expect to have may not be very happy or rewarding. Which is why I think it makes more sense, initially at least, for people to plan as if they'll live into their early-to-mid 90s -- or, in your case, about 30 years.

The second caveat you need to be aware of is that even if you plan as if you'll live into your 90s, that doesn't necessarily mean the 4% rule is the way to go. Why? Well, for one thing if the market goes into a deep and prolonged slump or you run into a period of truly subpar returns -- especially early in retirement -- the chances of your money lasting 30 years following the 4% rule can drop dramatically. Some research even suggests that, given today's low yields and the potential for low stock returns in the future, an initial withdrawal rate of 3% might be more appropriate if you want your savings to last three decades or more.

But there's also a risk to being too conservative -- namely, if you stint on withdrawals early in retirement and the markets perform decently, you could end up with a big pile of savings late in retirement, maybe even more than you started with. In a post earlier this year on his Nerd's Eye View blog, financial planner Michael Kitces noted that going all the way back to the 1870s, retirees who followed the 4% rule with a 60% stocks-40% bonds portfolio would have finished with more than double their starting principal after 30 years more than two-thirds of the time.