Forget the 4% Rule: This Investment Strategy Helps Retirees
For decades, conventional wisdom has held that financial planner William Bengen’s famous 4% rule, which he introduced in 1994, could safely carry retirees through their golden years.
The strategy, which begins by withdrawing 4% of your retirement savings in Year One and then increases that amount in line with inflation in subsequent years, should result in retirees having financial stability for 30 years.
However, over time, critics have suggested that the 4% figure should be closer to 5%. But the issue of strategy is not in its statistics. Instead, the problems are twofold:
- American life expectancy has increased by more than 27 percent since 1960, presenting the risk of retirees outliving their savings.
- The 4% rule base is based on depleting assets in your retirement account for income.
There is a better way – one that can save your nest egg and put you in a position to leave behind a wealth of productivity.
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Turn your Roth IRA into a dividend machine
Many Americans can increase their chances of generating reliable retirement income by adding a Roth IRA, or individual retirement account, to their savings plan. Because they’re funded with after-tax dollars, these accounts grow tax-free and can earn free dividends if you’re at least 59 1/2 years old and have held a Roth IRA for at least five years.
There are exceptions (such as foreign dividends, which are tax-free). But, by and large, the money earned in Roth IRAs is not taxed like ordinary income or capital gains like it is in regular trading accounts.
Of course, that same tax treatment applies to stock sales and subsequent withdrawals that retirees will have to make under the 4% rule. But if you retire with a dividend portfolio, the underlying assets – shares of yield-producing stocks and exchange-traded funds (ETFs) — it doesn’t have to be sold to generate income.
Instead, they continuously generate tax-free distributions (in some cases monthly) just to own them. The result: Your assets retain their principal value rather than wither away under the drawdown required by the 4% rule.
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The dividend snowball method
Because a dividend portfolio allows retirees not to they used their money, in addition, enabling them to transfer those shares to their relatives. But how is that best accomplished?
It depends on each investor, but it should start long before retirement and needs to be found an appropriate allocation between high-quality equity stocks, dividend growth ETFs and premium income ETFs.
Before those dividends are needed to supplement your other sources of retirement income, it’s important to adopt a dividend reinvestment plan — or DRIP — that reinvests payouts in companies or funds that automatically provide them.
Over time, a long-term dividend snowball strategy creates a growing income stream, with your DRIP leading to dividend accumulation until the day you close and start enjoying your portfolio yield.
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Where should you start?
Discussing this strategy with a financial planner is always a good start. In the meantime, it can’t hurt to start researching the positions you’d like to have in your stock portfolio.
That would include so-called Dividend Aristocrats (eg Aflac and Chevron) and Dividend Kings (eg Coca-Cola and Walmart): companies that have increased their dividend payments for 25 and 50 years in a row.
These aren’t flashy, AI-engineered, headline-grabbing, booming stocks. But they have become lucrative investors because of their reliable and sustainable dividend payout ratios.
For ETFs, dividend growth funds like the Schwab US Dividend Equity ETF can provide a combination of dividend and income appreciation, while high-yield funds like the JPMorgan Equity Premium Income ETF offer market-beating yields and monthly payments.
Importantly, no matter what your dividend portfolio structure looks like, it will allow you to not worry about going over its balance and bring you the comfort of knowing that you can leave behind the wealth you have worked hard to accumulate over decades.
