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There’s plenty of advice out there about the best methods for withdrawing savings for retirement, but not all of it still holds true, as the economy, stock market, and other retirement factors have changed over the years.
Though many retirees fear the possibility of running out of money too soon, they also risk not spending enough, according to Michael Finke, a professor of wealth management at the American College of Financial Services.
“I think that’s actually right now the biggest issue is that people don’t spend as much as they should [in retirement],” Finke said in an episode of Yahoo Finance’s Decoding Retirement podcast (see video above or listen below).
Finke compared some common retirement spending methods, specifically the 4% rule, the four-box method, and the Social Security/RMD strategy. An RMD, or required minimum distribution, is the minimum amount that individuals must withdraw annually from their retirement accounts, such as traditional IRAs and 401(k)s, starting at a specific age.
The 4% rule suggests that retirees with at least $1 million in their retirement savings should be able to spend $40,000, or 4% of their savings, in their first year of retirement and increase their subsequent yearly spending by the rate of inflation to ensure they do not run out of money.
Read more: Retirement planning: A step-by-step guide
Despite this once being a tried-and-true rule followed by many retirees, the method doesn’t hold up as well today.
“One of the problems is that people are simply living longer,” Finke stated. He noted that when the 4% rule was initially proposed as a solution, it didn’t consider those who live past the age of 65 or the possible expenses (like fees for a financial adviser) that many retirement plans currently include.
The four-box method suggests that retirees separate their retirement expenses into essential or necessary expenses (housing, groceries, etc) and discretionary expenses (hobbies and travel), then match their guaranteed sources of retirement income to the essential expenses and variable income to the discretionary or non-essential expenses.
“I’d like to say that you should match the risk of your investment portfolio to the variability of spending in your retirement budget and you shouldn’t budget inflexible, invariable expenses with any sort of an investment that could go up or down in value,” Finke said.
However, using the Social Security/RMD method also has some serious benefits. Finke claimed that by delaying when one begins to collect their Social Security benefits from age 65 to 70 and pulling from their other retirement assets to fund spending those first five years, a retiree can essentially ensure an inflation-protected income annuity. Delaying Social Security benefits from 65 to 70 can increase your monthly benefit significantly.