Many retirees worry about running out of money in retirement. In fact, a 2024 Allianz survey found that most Americans fear depleting their savings more than they fear death. Given the rising cost of living and unpredictable financial markets, it is essential to have a plan to make your money last.
Some retirees follow the 4% rule, while others choose a more conservative interest-only approach. Each method has benefits and risks, but the right strategy depends on individual circumstances. By understanding these options, retirees can make informed decisions and create a financial plan that offers long-term security.
Key Takeaways
Retirees need to carefully plan their withdrawal strategies to ensure that their nest egg lasts throughout retirement.
- The 4% rule suggests withdrawing 4% of total savings each year, adjusted for inflation, although it isn’t entirely fail‐safe and can be affected by market downturns and inflation.
- Interest‐only withdrawals involve taking only the interest or dividends from investments while keeping the principal intact, which helps preserve wealth but requires a large initial investment and may struggle in high‐inflation environments with low returns.
- A balanced approach that combines short‐term income with long‐term growth—using strategies like the ‘bucket method’—can provide financial security by managing risk and maintaining flexibility.
Using the 4% rule as a withdrawal strategy
One of the most well-known retirement strategies is the 4% rule. This rule suggests that retirees withdraw 4% of their total savings in the first year and then adjust that amount for inflation each year.
For example, if you retire with $1 million, you would withdraw $40,000 in the first year. In the second year, you would increase the withdrawal slightly to keep up with inflation. This method is designed to make your savings last at least 30 years.
While the 4% rule has worked for many retirees, it is not foolproof. Market downturns, inflation, and unexpected expenses can impact the sustainability of this approach. If a retiree experiences several years of poor investment returns early in retirement, their savings may not last as long as planned.
Preserving savings with interest-only withdrawals
An alternative approach involves withdrawing only the interest or dividends from investments while leaving the principal untouched. This strategy can help retirees make their money last indefinitely.
For instance, if someone has a $2 million portfolio earning 3% annually, they would receive $60,000 per year without reducing their original savings. This approach is often used by retirees who prefer to preserve their wealth for future generations or unforeseen expenses.
However, there are challenges to this method. It requires a large initial investment to generate enough interest income. Additionally, low-risk investments such as bonds and fixed-income funds may not provide high enough returns to cover living expenses, especially in a high-inflation environment. Retirees using this strategy must also be prepared for fluctuations in interest rates, which can impact annual earnings.
The risks and challenges of interest-only withdrawals
While the interest-only method sounds appealing, it has some risks. First, it demands a significant amount of money saved before retirement. A retiree with $500,000 earning 3% interest would only generate $15,000 annually. Unless supplemented by Social Security or other income sources, this may not be enough to maintain a comfortable lifestyle.
Inflation is another major concern. Over time, the cost of goods and services increases, reducing the purchasing power of a fixed-interest income. What may seem like a sufficient retirement income today may fall short in 10 or 20 years.
Market conditions can also impact interest-based investments. Bond yields fluctuate, and during periods of low interest rates, retirees may struggle to generate enough income. Some retirees attempt to offset this by investing in dividend-paying stocks, but these come with higher risks.
Combining income and growth as a balanced approach
Because both the 4% rule and interest-only withdrawals come with risks, many retirees opt for a more flexible approach that blends different strategies. A balanced plan often involves structuring investments based on when the funds will be needed. One effective method is the “bucket strategy,” which divides assets into different timeframes.
Retirees can set aside enough cash or short-term bonds to cover their expenses for the next three to five years, ensuring they have a financial cushion during market downturns. For mid-term needs, they invest in conservative assets like bonds or dividend-paying stocks, which provide both income and stability.
Meanwhile, long-term funds are placed in growth-oriented investments such as stocks, which help counteract inflation and support financial security over the years.
With this, retirees can draw from safer investments when the market is down while allowing their long-term assets to grow. This method balances security with growth potential, reducing the risk of running out of money while maintaining financial flexibility.
Adapting to changing financial conditions
A retirement strategy should not be set in stone. Market changes, inflation, unexpected expenses, and shifts in personal needs require ongoing adjustments. Retirees should regularly review their financial plans to ensure they remain on track.
Having flexibility is key. If the market is performing well, retirees may be able to withdraw slightly more. If the market declines, temporarily reducing withdrawals can help prevent depleting savings too quickly.
Ensuring a stable financial future in retirement requires careful planning and a well-thought-out withdrawal strategy. While the 4% rule offers a structured approach, it does not work for everyone. The interest-only strategy provides principal protection but may not generate enough income.
A balanced approach that combines short-term income with long-term growth is often the best solution. By seeking professional advice and adjusting plans over time, retirees can increase the likelihood of maintaining their savings and enjoying a financially secure retirement.
