If you are close to retirement or are currently retired, you may have heard about the 4% rule. It was designed to help retirees determine how much of their portfolio they should withdraw in the first year of retirement (indexed to inflation in future years) to increase the probability of their money lasting a lifetime. It is based on equity and fixed income return history for the period xxxx to xxxx.

The 4% rule is a heuristic

A heuristic is any approach to problem solving that employs a practical method that is not guaranteed to be optimal or rational, but instead is sufficient for reaching an immediate goal.

Here’s why the 4% rule shouldn’t be relied upon when making long-term spending decisions.

You own real estate

The 4% rule assumes that your investment portfolio is fully responsible for funding your retirement lifestyle needs. An investor with real estate equity may be comfortable using some or all of that equity during their lifetime. This could be a principal residence, leisure property or investment property.

With real estate as another asset, you might be comfortable – and it may be prudent – to draw more aggressively on your portfolio in the early years of retirement and replenish those savings through the sale of real estate down the road.

If this sounds like you, 4% could be an artificially low drawdown rate. On the other hand, those that don’t have other assets should be a little more cautious about the rate of their portfolio withdrawals.

You have estate aspirations

Another variable is whether or not you want to leave an inheritance for loved ones or charities. The more money you want to pass on after you die, the less money you should spend during your retirement years to make sure that money is there.

Some people use life insurance to make sure there is a certain estate value at the end of the day, but those policies aren’t free. There are premiums that will increase your cost of living in retirement and force you to drawdown on your savings more aggressively. Your ability to afford the premiums over the long term is essential when using this estate funding strategy.

Clients who want to leave an inheritance are often surprised by the degree to which it curtails their retirement spending capacity. When we quantify the impact, some clients say, “On second thought…the kids will be fine! Whatever is left will be good enough.”

You have pension income

Finally, are you one of the lucky Canadians that have a defined benefit pension that is indexed to inflation every year? If that is the case, it might be safe for you to draw more aggressively on your savings in the early years of retirement knowing you have pension income that will provide you with lifetime support during your later years.

The bottom line is that rules of thumb are generalities. They are shortcuts that make decision making faster and easier, but certainly not better. The best way to find a withdrawal rate that works best for you is through a customized planning analysis.

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  • This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.