Personal Finance

Why new retirees may need to rethink the 4% rule

Published

18 hours ago

December 17, 2024

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A popular retirement strategy known as the 4% rule may need some recalibration for 2025 based on market conditions, according to new research.

The 4% rule helps retirees determine how much money they can withdraw annually from their accounts and be relatively confident they won’t run out of money over a 30-year retirement period.

According to the strategy, retirees tap 4% of their nest egg the first year. For future withdrawals, they adjust the previous year’s dollar figure upward for inflation.

But that “safe” withdrawal rate declined to 3.7% in 2025, from 4% in 2024, due to long-term assumptions in the financial markets, according to Morningstar research.

Specifically, expectations for stock, bond and cash returns over the next 30 years declined relative to last year, according to Morningstar analysts. This means a portfolio split 50-50 between stocks and bonds would have less growth.

While history shows the 4% rule is a “reasonable starting point,” retirees can generally deviate from the retirement strategy if they’re willing to be flexible with annual spending, said Christine Benz, director of personal finance and retirement planning at Morningstar and a co-author of the new study.

That may mean reducing spending in down markets, for example, she said.

“We caution, the assumptions that underpin [the 4% rule] are incredibly conservative,” Benz said. “The last thing we want to do is scare people or encourage people to underspend.”

How the 4% rule works

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In many ways, drawing down one’s nest egg is harder than growing it.

Pulling out too much money early in one’s retirement years — especially in down markets — generally raises the odds that a saver will run out of money in later years.

There’s also the opposite risk, of being too conservative and living well below one’s means.

The 4% rule aims to guide retirees to relative safety.

Here’s an example of how it works: An investor would withdraw $40,000 from a $1 million portfolio in the first year of retirement. If the cost of living rises 2% that year, the next year’s withdrawal would rise to $40,800. And so on.

Historically — over a period from 1926 to 1993 — the formula has yielded a 90% probability of having money remaining after a three-decade-long retirement, according to Morningstar.

Using the 3.7% rule, the first-year withdrawal on that hypothetical $1 million portfolio falls to $37,000.

That said, there are some downsides to the framework of the 4% rule, according to a 2024 Charles Schwab article by Chris Kawashima, director of financial planning, and Rob Williams, managing director of financial planning, retirement income and wealth management.

For example, it doesn’t include taxes or investment fees, and applies to a “very specific” investment portfolio — a 50-50 stock-bond mix that doesn’t change over time, they wrote.

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It’s also “rigid,” Kawashima and Williams said.

The rule “assumes you never have years where you spend more, or less, than the inflation increase,” they wrote. “This isn’t how most people spend in retirement. Expenses may change from one year to the next, and the amount you spend may change throughout retirement.”

How retirees can tweak the 4% rule

There are some tweaks and adjustments retirees can make to the 4% rule, Benz said.

For example, retirees generally spend less in the later years of retirement, in inflation-adjusted terms, Benz said. If retirees can enter retirement and be OK with spending less later, it means they can safely spend more in their earlier retirement years, Benz said.

This tradeoff would yield a 4.8% first-year safe withdrawal rate in 2025 — much higher than the aforementioned 3.7% rate, according to Morningstar.

Meanwhile, long-term care is a big “wild card” that could increase retirees’ spending in later years, Benz said. For example, the typical American paid about $6,300 a month for a home health aide and $8,700 a month for a semi-private room in a nursing home in 2023, according to Genworth’s latest cost of care study.

Additionally, investors may be able to give themselves a bit of a raise when markets are up significantly in a given year and reduce withdrawals when markets are down, Benz said.

If possible, delaying Social Security claiming to age 70 — thereby increasing monthly payments for life — may be a way for many retirees to boost their financial security, she said. The federal government adds 8% to your benefit payments for each full year you delay claiming Social Security benefits beyond full retirement age, until age 70.

However, this calculus depends on where households get their cash in order to defer the Social Security claiming age. Continuing to live off job income is better, for example, than leaning heavily on an investment portfolio to finance living costs until age 70, Benz said.

Personal Finance

How to leverage the higher 401(k) plan contribution limit for 2025

Published

11 hours ago

December 17, 2024

Business Finance News

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If you’re eager to save more for retirement, it’s not too early to boost 401(k) plan contributions for 2025, financial experts say.

For 2025, you can defer up to $23,500 into 401(k) plans, up from $23,000 in 2024. For workers age 50 and older, the 401(k) catch-up contribution remains at $7,500 for 2025.

But there’s a “super funding” opportunity for 401(k) catch-up contributions for a subset of savers, according to Tommy Lucas, a certified financial planner and enrolled agent at Moisand Fitzgerald Tamayo in Orlando, Florida.

Enacted via Secure 2.0, the 2025 catch-up contribution limit will increase to $11,250 for employees ages 60 to 63, which brings the 401(k) deferral total to $34,750 for these investors.

“Probably no one knows about the extra increase,” and it could take time before the general public is aware of the new opportunity, said Boston-area CFP and enrolled agent Catherine Valega, founder of Green Bee Advisory.

However, boosting contributions later could still be beneficial for savers in this age range, experts say.

Increase 401(k) deferrals for 2025 now

If you plan to adjust 401(k) deferrals for 2025, “now is the time to be doing it,” Valega said.

Typically, it takes a couple of pay periods for 401(k) contribution changes to go into effect, and you could miss some higher contributions in January by waiting, she said.

If you miss bigger deposits early, you can still max out your plan by boosting deferrals later in the year. But higher percentages can “impact cash flow more than people are typically willing to do,” Valega said.

Lucas said he updated next year’s 401(k) contributions for his clients in early December.

“It’s already set for next year,” he said. “We’re on pace, starting with the first payroll.”

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Of course, many workers can’t afford to max out their 401(k) plan every year.

Roughly 14% of employees maxed out 401(k) plans in 2023, according to Vanguard’s 2024 How America Saves report, based on data from 1,500 qualified plans and nearly 5 million participants.

Personal Finance

Student loan forgiveness chances lost to those who refinance: CFPB

Published

12 hours ago

December 17, 2024

Business Finance News

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With the Federal Reserve’s recent moves to lower interest rates — and further cuts on the horizon — some federal student loan borrowers are wondering if now is a good time to refinance.

“We are already seeing more borrowers tempted to refinance their federal loans,” said Betsy Mayotte, president of The Institute of Student Loan Advisors.

Refinancing your federal student loans turns them into a private student loan and transfers the debt from the government to a private company. Borrowers usually refinance in search of a lower interest rate.

But the Consumer Financial Protection Bureau has new warnings about refinancing student debt.

In a report published Monday, the CFPB said that private lenders use “deceptive” practices in their marketing and disclosure materials, misleading student borrowers about a key pitfall of refinancing: Those who do so lose access to federal student loan forgiveness options.

“Companies break the law when they mislead student borrowers about their protections or deny borrowers their rightful benefits,” said CFPB Director Rohit Chopra. “Student loan companies should not profit by violating the law.”

Federal forgiveness chances dashed with refinancing

Some private lenders give the wrong impression “that refinancing federal loans might not result in forfeiting access to federal forgiveness programs, when, in fact, it was a certainty,” the CFPB report says.

The federal government offers a range of student debt forgiveness programs, including Public Service Loan Forgiveness and Teacher Loan Forgiveness.

PSLF allows certain not-for-profit and government employees to have their federal student loans cleared after 10 years of on-time payments. Under TLF, those who teach full-time for five consecutive academic years in a low-income school or educational service agency can be eligible for loan forgiveness of up to $17,500. These options are not available to private student loan borrowers.

Borrowers refinancing would also not be eligible for one-off forgiveness efforts like President Joe Biden’s Plan B.

Private student loan borrowers who are struggling to pay their bills don’t have a right to an income-driven repayment plan, either.

IDR plans allow federal student borrowers to pay just a share of their discretionary income toward their debt each month. The plans also lead to debt forgiveness after a certain period.

Borrowers who refinance their student loans lose access to these federal relief options, the CFPB said.

And this has cost borrowers.

“The lenders profited from borrowers paying the full amount of their loans, when the borrowers otherwise potentially could have had some or all of those loans forgiven,” the bureau wrote in its report.

Lenders do inform borrowers of what benefits they may give up by making moves like refinancing, said Scott Buchanan, executive director of the Student Loan Servicing Alliance, a trade group for student loan servicers.

Buchanan said the government’s changing promises around student loan forgiveness has led to a lack of clarity. (Republican-led legal challenges have stymied the Biden administration’s efforts to deliver wide-scale student loan forgiveness to borrowers.)

“That volatility and confusion is something the Bureau needs to take up with the Department of Education,” Buchanan said.

But the federal government’s long-standing student loan forgiveness programs and other relief measures are reasons alone to think twice before refinancing, Mayotte said.

“We almost always very strongly recommend against it,” she said.

Personal Finance

Advisors remain reluctant to recommend crypto, even as prices soar

Published

13 hours ago

December 17, 2024

Business Finance News

Digital assets have rallied since the November U.S. election — with bitcoin notching a new high above $107,000 on Monday — and continue to gain ground as President-elect Donald Trump details his pro-cryptocurrency policy plans.

Still, many financial advisors remain wary.

“As traditional long-term planners, we currently do not incorporate crypto in our portfolio allocations,” said certified financial planner Marianela Collado, CEO of Tobias Financial Advisors in Plantation, Florida. She is also a certified public accountant. “We always advise our clients to put in crypto what you’re not necessarily needing for retirement, what you’re comfortable losing.”

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To be sure, regulatory uncertainty remains a clear area of concern for financial advisors when it comes to recommending crypto investments to clients.

In April, when crypto prices were lower, an annual survey of 2,000 financial advisors by Cerulli Associates found that 59% don’t currently use cryptocurrencies or plan to in the future. Another 26% said they don’t use it now but expect to in the future.

Meanwhile, about 12% of advisors said they use cryptocurrencies based on clients’ requests, according to the Cerulli report, and less than 3% of advisors said they use crypto based on their own recommendations.

ETFs an ‘easy solution’ to add crypto

If investors are interested in crypto, CFP Ashton Lawrence at Mariner Wealth Advisors in Greenville, South Carolina, advises many clients to use exchange-traded funds.

“It’s truly depending upon what the client is looking to achieve and how easy they feel in navigating this market,” he said. “If they’re looking for an easy solution. ETFs might be the best way to go.”

Spot bitcoin ETFs, first available in January, now have more than $100 billion in assets under management, which is about 1% of the overall ETF market.

“Bitcoin ETFs have become the vehicle of choice for bitcoin holders,” Brian Hartigan, global head of ETFs at Invesco, said during CNBC’s “Halftime Report” on Dec. 9.

Lawrence recommends clients interested in crypto limit the allocation to no more than 1% to 5% of their overall portfolio.

Most financial advisors agree that whether to have crypto investments in your portfolio depends on your risk tolerance, financial goals and time horizon.