Connect with us

Hi, what are you looking for?

Investing

The Reverse 4% Rule Puts Retirement Income, Spending Into Perspective

You’ve probably heard of the “4% rule” for making withdrawals from your retirement account but how about trying “the reverse 4% rule?”

Flipping this investing guideline on its head can give retirees a new way to think about their money in retirement. Instead of multiplying your total nest egg by 4%, divide your withdrawals or contributions by 4% and you can get a sense of how much a specific financial decision can affect your future retirement lifestyle and security.

The result? Earning $50 an hour has the same immediate effect as having an additional $1,250 in savings. It sounds too good to be true, but it just requires a new mind-set.
Let’s review: The 4% rule, devised by planner William Bengen in the 1990s, states that you can withdraw that percentage from a portfolio of stocks and bonds each year, adjusted for inflation, and your portfolio will last at least 30 years.
The reverse 4% rule tells you what effect extra income or added expenses have on your retirement nest egg.
Turning a side-gig into $250,000
Consider the case of a retiree socked with unexpectedly high costs in inflationary times. What happens if, instead of withdrawing more cash to meet higher living expenses, he or she returns to work, consulting 5 hours a week at $50 an hour. Does the extra income make much of a difference to their seven-figure retirement account?

Let’s do the math:
Suppose the retiree’s nest egg is $2 million, which under the 4% rule, supports an $80,000 annual withdrawal. If the retiree works that consulting gig for 10 months of the year, earning another $10,000 annually, the extra income is the equivalent of seeing his or her retirement savings temporarily jump from $2 million to $2.25 million.
Or our retiree can withdraw just $70,000 from their retirement accounts, leaving the extra $10,000 to continue compounding for the rest of their retirement years. “The primary benefit is you have more money saved,” said Michael Finke, professor of wealth management at the American College of Financial Services. “That’s the surefire way to reduce the cost of funding retirement while increasing the amount of money you can safely spend.”
To be sure, the effect of the part-time job is like having the added quarter-million in assets only for as long as the retiree keeps working, while the $2 million nest egg will safely provide income for 30 years. On the other hand, the additional $10,000 buys a nice balcony stateroom for a two-week cruise to St. Maarten without taking a single dollar out of investments.
Why you may opt for a used car

Reframing financial decisions along these lines isn’t a new concept. Consider the personal finance scolds who cite the “latte rule” to argue that anyone purchasing a daily cup of coffee is dooming themselves to a miserable financial future because, at 6% for 30 years, the $3.50 they fritter away each day would compound to nearly $107,000.
At a rate of 4%, every $1,000 taken out of retirement assets reduces future annual
withdrawals by $40 a year. Take the case of buying your retirement car. You have worked hard all your life, so why not upgrade from a $25,000 reliable used car to a $60,000 spanking new SUV?
So the extra $35,000 you are spending on the car is the equivalent of cutting your income by $1,400 a year, or $117 a month for the next 30 years. Looking at a number like that makes it much easier to go with the used car.

Income versus expenses versus quality of life
Every trip to the store doesn’t require firing up your iPhone calculator to run the numbers on the difference between buying the good Scotch versus the cheap stuff. Only you know how hard you worked and scrimped to hatch your nest egg, and how to balance the risk of outliving your money versus spending some of it to enhance your quality of life.
While that luxury car may be a splurge, you may decide it is worth spending an extra $50,000 to get the house you really want. Yes, the 4% rule tells you that you are lowering your annual draw by $2,000. In this instance, unlike the car, at least you’re sinking your money into an appreciating asset that, if need be one day, you can borrow against.
It doesn’t take any math to understand that adding to your retirement fund or spending less of it each year will make your money last longer. But some simple division can help you gain some perspective on the long-term results.

Write to [email protected]

Read the full article here

Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *

You May Also Like

Videos

Watch full video on YouTube

Videos

Watch full video on YouTube

Videos

Watch full video on YouTube