When planning for retirement, avoid this costly retirement withdrawal strategy. Many people turn to the well-known 4% Rule for guidance. However, relying too heavily on this strategy can put your retirement savings at serious risk. In this post, we’ll explore the potential pitfalls of the 4% Rule and outline strategies to keep your retirement plan secure.
Understanding the 4% Rule
The 4% Rule is a guideline suggesting you withdraw 4% of your portfolio in the first year of retirement and adjust that amount for inflation each year. Ideally, this strategy aims to help your savings last for 30 years, even with market fluctuations.
But does this strategy hold up in the real world?
The Story of Christie’s Retirement Plan
Meet Christie. At age 65, she retired with a $2 million portfolio, receiving $20,000 annually from CPP and OAS. Christie planned to withdraw $80,000 from her portfolio each year to maintain her $100,000 lifestyle until age 90, using the 4% Rule. On paper, this plan seemed sound.
However, when we reviewed her retirement withdrawal strategy, we found two major flaws.
1. The Impact of Inflation
Christie overlooked how inflation would erode her buying power over time. Her initial $80,000 withdrawal might cover her expenses in year one, but with an average inflation rate of 3%, she’d need $82,400 in year two, and even more in subsequent years. By age 90, her portfolio would dwindle to around $420,000—a far cry from the $1.8 million she expected.
Key Takeaway: Always adjust your withdrawals for inflation to maintain your lifestyle.
2. The Overlooked Cost of Taxes
The second issue was taxes. Christie had $200,000 in her TFSA, but most of her savings were in her RRSP. Once her TFSA funds were exhausted, she’d need to draw from her RRSP, where taxes would significantly reduce her net income.
For example, after her TFSA was depleted, she’d need to withdraw $110,000 from her RRSP to net the same $80,000 after taxes. This increased her withdrawal rate to 5.5%, putting more pressure on her portfolio.
Key Takeaway: Consider taxes in your retirement withdrawal strategy. The 4% Rule doesn’t account for this impact, so plan accordingly.
How We Adjusted Christie’s Plan
Faced with these challenges, Christie needed to make some changes to ensure her funds lasted throughout retirement.
Adjusting Expenses
We reviewed Christie’s goals and identified that travel was her biggest discretionary expense. She loved traveling but agreed she wouldn’t travel as extensively in her later years. So, we adjusted her spending to $100,000 per year, increasing with inflation until age 77. After that, we reduced her expenses to $72,000 per year (in today’s dollars), adjusting for inflation.
Result: This extended her funds to age 88, much closer to her life expectancy.
Targeting a Higher Return
Next, we aimed for a higher rate of return. Christie was conservatively invested with an expected 4% return. By slightly increasing her allocation to stocks, we targeted a 5% return. She was okay with this compromise if it would significantly affect her long-term plan, and we could implement this approach by using the bucketing strategy. You can check out that strategy here.
Result: Her funds were now projected to last until age 93, providing a buffer in case she lived longer.
Optimizing Her Withdrawal Strategy
We also needed to optimize how Christie withdrew her funds. Instead of depleting her TFSA and then relying on her RRSP, we adopted a more tax-efficient approach:
- We spread her TFSA withdrawals over the same period as her higher expenses, keeping her taxable income low.
- Once her expenses decreased, we increased RRSP withdrawals and re-contributed any extra to her TFSA.
Result: By age 90, all her funds were sheltered in her TFSA, increasing her net estate to $394,000, compared to $177,000 under her original plan.
Final Thoughts: Be Proactive with Your Retirement Withdrawal Strategy
Sometimes, compromises are necessary to secure your retirement. Christie’s story highlights the importance of reviewing your plan, considering inflation, taxes, and market returns, and making adjustments as needed.
If you’re planning to retire soon, it’s crucial to review your withdrawal strategy and ensure you’re on track to meet your goals. You still have time to make adjustments if needed!
