4% Rule Busted

Let’s say you have a 1 million dollar nest egg, and you want this to provide an income for life. The 4% rule says you should be able to take 4% of your nest egg income and have it last for the rest of your life. Well, 4% of $1,000,000 is $40,000. You still have to pay tax on this because it’s more than likely in a 401(k) or IRA.

Assuming tax rates are the same, you’ll pay 15% federal and about 6% state (3.07% in my home state of Pennsylvania), unless you live in a state with no income tax. That puts you at about $31,600 or just over $2600 per month. I don’t know about you, but that doesn’t sound too exciting for a retirement income.

Now what happens if your $1,000,000 takes a 30% hit during a market crash during your retirement? Now you’ve got $700,000 and your monthly income is down to $1843.

The reason the 4% rule doesn’t work is because of something called “The Sequence of Returns.”

Your nest egg and retirement income can vary greatly depending on whether the market goes up or down in the first couple years of your retirement. For example if you take the exact same sequence of returns, with some ups and some downs, the sequence with your withdrawals starting in an up market (High early returns) your money would last 37 years. If you started withdrawals in a down market (low early returns) your money would only last 24 years.

This means your retirement could run out 13 years sooner, just by the luck of the draw.

You can’t guess what the market will do once you retire. You basically hope it goes up not down, once you retire. This is pretty silly considering the very nature of the market is boom…then bust. It’s an ongoing cycle that is basically guaranteed to go up and down.

So following the “Nest Egg” retirement strategy, you are simply ‘hoping for the best’…and hope is not a strategy.

If you are one of the unlucky ones to retire in a down market, it could cost you big time.

The goal should no longer be to just make a certain ‘income level.’ It should be to generate a passive income that you are able to live on should the worst happen.

There is a better way

Now let’s compare how a $1,000,000 nest egg in the stock market compared to the cash flow in a 101 Plan Indexed insurance policy that had $1,000,000 in cash value.

Remember the stock account after tax would produce about $31,000 after tax income to last until age 100 (Assuming the best case scenario in the sequence of returns).

Assuming 6.75% growth (which is pretty conservative) the 101 Plan would put out $110,900 tax advantaged (no income tax) cash flow until you hit age 100.

Talking pre-tax money, the stock account produced $40,000; factoring current tax rates the $110,000 in tax advantaged money would be closer to $145,000 in pre-tax income.

This is why the 101 Plan has become such a popular retirement strategy, plus the fact that it has insurance and potentially a long term care benefit included, you are getting much more for your money. Contact me for more information on the 101 plan.