Retirement Rules of Thumb to Question

In financial and retirement planning, there are a lot of rules of thumb. It’s often difficult to decipher which are good and which are bad. Don’t fall victim to bad advice. Know which ones to follow and which ones to throw out the window.

1.Have three to six months of savings in an emergency fund

While this is generally a good rule of thumb to follow, those who are close to, or already in retirement must consider the inflation risk that an emergency fund sitting in the bank is exposed to. If your money is in a bank account, it very likely will not keep up with inflation. If you have a three month emergency fund that sits in the bank for 20 or 30 years, the opportunity cost and inflation risk could be detrimental. In order to avoid these sorts of risks but still have money that’s available for an emergency, consider a Roth IRA, penalty free withdrawals from an annuity, or holding modestly sized non-qualified liquid investments.

2. Use your age to determine your portfolio’s appropriate percentage of stocks

This is a rule of thumb we seriously question. Typically the rule states that you should take 100 and subtract your age. The amount left over is the percentage of your portfolio that should be invested in stocks. If you’re 60 years old, should you have 40% of your money in stocks or mutual funds? The answer depends on you and your risk tolerance. It can’t be answered by a rule of thumb. If the answer to that question is yes, ask yourself if you’d be alright losing 40% of your portfolio? Or, would you be alright having 40% of your portfolio’s income not guaranteed? This doesn’t even take into account where the other 60% of your money is invested. Most people would answer “no” to those follow up questions. If that’s the case for you, throw this rule of thumb out the window.

3. You will need $1,000,000 to retire comfortably

This rule may or may not be true for you. The problem is this goal doesn’t address the real cause of your “comfort”. The thing that will allow you to be comfortable in retirement is a consistent income stream that provides you the ability to live your desired lifestyle. Even if you did start with $1 million in your retirement accounts, not having an income plan could make you very “uncomfortable”. Furthermore, you might find “discomfort” in a volatile and unpredictable income stream.

We suggest you start at the end. What do you want to do during retirement? What sort of trips do you want to take, hobbies do you want to have and lifestyle do you want to lead? What sort of expenses will you have during retirement? Will you have a mortgage, car payments or other bills to pay? Start there and that will tell you how much income you’ll need. Then you need to talk about income generators, which leads to the next “rule of thumb”.

4.You should draw out 4% of your nest egg per year for income during retirement

If you’re planning to draw down your assets at a certain percentage every year, Morningstar suggests a 3% withdrawal stream. Taking that into account, this rule is flawed. Taking $1 million and calculating 3% is $30,000 per year. Then factor in taxes at 15% and you’ll come out with $25,500 per year in take home income. After that, factor in Social Security and taxes on your Social Security (up to 85% can be taxed). Will that be sufficient to cover your expenses and desired lifestyle?

If the answer is no, and you’re convinced you want to draw out 3% per year, you’ll need more than $1 million. If you’re not so convinced you want to draw down 3% per year and you’d like to look at other income generating options, there could be a better solution that wouldn’t require you to save $1 million for retirement.

Everyone’s situation is different. For some, these rules of thumb may be a good fit but for others, that’s not the case. We encourage you to question these “rules” and ultimately speak to a qualified retirement income planning specialist about your personal situation.