The 4% Rule for Retirement: Will Your Money Last Long Enough?

Have you been scratching your head about how much money you can safely withdraw from your retirement savings without running out? You’re not alone! The 4% rule has been a popular guideline for retirees since the 1990s but there’s more to it than meets the eye. Let’s dive into what this rule really means for your golden years.

What Is the 4% Retirement Rule?

The 4% rule is a retirement withdrawal strategy that says retirees can safely take out 4% of their retirement portfolio in the first year of retirement and then adjust that amount for inflation in the years that follow. You want your nest egg to last at least 30 years.

In 1994, financial advisor Bill Bengen came up with this rule and published his research in the Journal of Financial Planning. He compared different withdrawal rates to market data from 1926 to 1976, which included some very bad economic times like the Great Depression and the stagflation of the 1970s.

Here’s the simple formula:

1. First year of retirement: Withdraw 4% of your total portfolio
2. Each following year: Adjust the previous year’s withdrawal amount for inflation

For example, if you’ve saved $1 million for retirement:

• Year 1: You’d withdraw $40,000 (4% of $1 million)
• Year 2: If inflation is 2%, you’d withdraw $40,800 ($40,000 × 1.02)
• Year 3: If inflation is 3%, you’d withdraw $42,024 ($40,800 × 1.03)

And so on, regardless of market performance.

How the 4% Rule Actually Works in Practice

Many folks misunderstand the 4% rule. It’s NOT about withdrawing 4% of your portfolio’s value each year (which would mean different dollar amounts as your portfolio fluctuates). Instead, you take 4% in the first year only, and then you adjust that initial dollar amount for inflation going forward.

Let me break this down with a simple example:

Scenario: You have $500,000 in retirement savings

• Year 1: Withdraw $20,000 (4% of $500,000)
• Year 2: If inflation is 2.5%, withdraw $20,500 ($20,000 × 1.025)
• Year 3: If inflation is 1.8%, withdraw $20,869 ($20,500 × 1.018)

Notice how we’re not recalculating 4% of the remaining balance each year? That’s a common misconception!

The Original Testing Behind the 4% Rule

Bengen’s analysis wasn’t just some random theory – it was based on rigorous testing. He examined how portfolios would have performed for retirees beginning retirement in each year from 1926 to 1976, with projections running for up to 50 years.

What’s amazing is that the 4% rule held up even when the market was really bad:

• The 1929 stock market crash (stocks down 61%)
• The 1937-1941 decline (stocks down 33.3%)
• The 1973-1974 bear market (stocks down 37.2%)

Following the 4% rule led to portfolios that survived for at least three years, even during these market disasters. That’s pretty reassuring!.

Important Assumptions Behind the 4% Rule

Before you start planning your retirement based solely on the 4% rule, you should understand some key assumptions baked into it:

1. Asset Allocation Matters… A Lot

Bengen’s research assumed a specific portfolio mix: 50% in stocks (S&P 500) and 50% in intermediate-term Treasury bonds. This balanced approach is crucial to the rule’s success.

Interestingly, Bengen found that having too FEW stocks was actually more dangerous than having too many. Portfolios with less than 25% in stocks struggled to last. If you’re comfortable with more risk, he suggested up to 75% in stocks could potentially create more wealth while still maintaining longevity.

2. Investment Fees Can Break the Rule

The original research didn’t account for investment management fees. If you’re paying 1% or more to an advisor plus additional mutual fund fees, your effective withdrawal rate might be closer to 3% than 4%.

Those who invest in low-cost index funds will be much closer to the rule’s original assumptions.

3. Inflation Can Be a Bigger Threat Than Market Crashes

Surprisingly, the portfolios that struggled the most weren’t those that began during the Great Depression. They were those that started retirement just before the high inflation of the 1970s!

Why? Because when inflation is high, retirees must withdraw significantly more each year just to maintain their purchasing power. The 1973-1974 period saw inflation of 22.1%, forcing much larger withdrawals. By contrast, the Depression years actually experienced deflation of 15.8%, allowing for smaller withdrawals while maintaining purchasing power.

Is the 4% Rule Still Valid Today?

Some financial experts have questioned whether the 4% rule still works in today’s environment of potentially lower returns and historically low interest rates. Others suggest that 5% might be feasible in most market scenarios, while some conservative advisors recommend 3% as a safer withdrawal rate.

According to Michael Kitces, a respected financial planner, the 4% rule has actually held up well through recent crises like the 2000 tech crash and the 2008 global financial crisis. He notes that those who retired in 2008 are already doing better than many historical scenarios that were included in Bengen’s original research.

The reality is that the right withdrawal rate depends on your personal situation:

• Your planned retirement length (30+ years?)
• Your investment mix
• Your willingness to be flexible with spending
• Current market conditions
• Your other sources of income (Social Security, pensions, etc.)

Alternatives and Improvements to the 4% Rule

The Flexible Withdrawal Approach

Instead of rigidly sticking to inflation-adjusted withdrawals, consider adjusting your spending based on market performance:

• Reduce withdrawals temporarily during bear markets
• Potentially increase withdrawals slightly during strong markets
• Even a 5% reduction during market downturns can substantially improve portfolio longevity

Personalized Withdrawal Rates

Charles Schwab suggests tailoring your withdrawal rate based on:

1. Your time horizon: A 10-year retirement might support a 10.6% initial withdrawal rate, while a 30-year retirement would be closer to 4.2%
2. Your asset allocation: More conservative portfolios support lower withdrawal rates
3. Your confidence level: Aiming for 75-90% confidence that your money will last is reasonable for most retirees

Consider Your Full Financial Picture

Don’t forget to factor in:

• Social Security benefits
• Pension income
• Annuity payments
• Required Minimum Distributions (RMDs)
• Tax implications of withdrawals

When the 4% Rule Might Not Work for You

The 4% rule isn’t one-size-fits-all. It might not be appropriate if:

1. You’re retiring early – The rule is designed for a 30-year retirement period, not 40+ years
2. You have very high investment fees – Fees above 1% annually will significantly reduce the rule’s effectiveness
3. You need spending flexibility – Some years you might need more than the formula allows
4. You have an extremely conservative portfolio – Less than 25% in stocks may not generate enough growth
5. You have no flexibility to reduce spending – If all your expenses are fixed, you can’t adjust during market downturns

A Practical Approach to Using the 4% Rule

Here’s my advice for applying the 4% rule in real life:

1. Use it as a starting point, not an absolute rule
2. Revisit your plan annually – Don’t just set it and forget it
3. Be flexible with spending – Especially during market downturns
4. Keep investment costs low – Use index funds when possible
5. Maintain a balanced portfolio – Around 50/50 stocks and bonds, adjusted for your risk tolerance
6. Consider working with a financial advisor to create a personalized withdrawal strategy

The Bottom Line: Is the 4% Rule Right for You?

The 4% rule provides a simple, reasonable starting point for retirement planning. While it’s stood the test of time through various market conditions, it’s not perfect for everyone.

I believe the best approach is to use the 4% rule as a guideline while maintaining flexibility. Your retirement is unique, and your withdrawal strategy should be too. Regular check-ins on your portfolio and willingness to adjust when needed will serve you better than rigid adherence to any single rule.

Remember, the goal isn’t just making your money last—it’s enjoying the retirement you’ve worked so hard to achieve!

FAQs About the 4% Retirement Rule

How much money do I need to retire using the 4% rule?

To estimate, multiply your desired annual withdrawal by 25. For example, if you want $40,000 annually from your portfolio, you’d need approximately $1 million ($40,000 × 25).

Does the 4% rule work for early retirement?

Not really. The rule was designed for a 30-year retirement period. If you’re retiring in your 40s or 50s, you might need a more conservative withdrawal rate like 3% or 3.5%.

What if I have other income sources besides my portfolio?

The 4% rule applies only to your investment portfolio. If you have Social Security, pensions, or other income, you may not need to withdraw the full 4% to meet your spending needs.

Can I withdraw more than 4% if the market performs well?

While you could, it’s generally not recommended to increase your base withdrawal amount when markets are strong. However, some retirees do take occasional “bonus” withdrawals for special expenses during strong market years.

What’s the biggest risk to the 4% rule?

Sustained high inflation combined with poor market returns presents the biggest challenge to the 4% rule. This combination forces you to withdraw more while your portfolio is already struggling.