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Within the vast topic of retirement, the concept of “the 4% rule” hits right at the core of most people’s concerns: how much money is enough money to have in your savings when you finally reach retirement?
There’s no shortage of advice about how much you should save for retirement, but there’s a lot less clarity around how much money you’ll ultimately need to withdrawal when the time comes. This is what the 4% rule addresses.
What is the 4% rule?
The 4% rule is a popular retirement withdrawal strategy that suggests retirees can safely withdraw the amount equal to 4% of their savings during the year they retire and then adjust for inflation each subsequent year for 30 years.
The 4% rule is a simple rule of thumb as opposed to a hard and fast rule for retirement income. Many factors influence the safe withdrawal rate such as risk tolerance, tax rates, the tax status of your portfolio (i.e., the ratio of tax-deferred assets to taxable assets to tax-free assets) and inflation, among others.
The upside to this go-to rule is its simplicity. Having a guideline for retirement spending that’s clean and simple makes planning much easier. The downsides are that it’s a number that might become outdated by the time you reach retirement, and it doesn’t adjust for market conditions, which surely will change year to year.
Let’s dig into the 4% rule a bit more — and unpack whether or not it might be a helpful guideline for your own retirement planning or whether it’s ill-equipped for the dynamic set of factors that rule over long-term savings and future spending.
History of the 4% rule
In 1994, using historical data on stock and bond returns over a 50-year period — 1926 to 1976 — financial advisor William Bengen challenged the prevailing narrative that withdrawing 5% yearly in retirement was a safe bet.
Based on a deep dive into the half century of market data, Bergen concluded that essentially any conceivable economic scenario (even the more tumultuous ones) would allow for a 4% withdrawal during the year they retire and then they’d adjust for inflation each subsequent year for 30 years.
Bengen used a 60/40 portfolio model (60% stocks , 40% bonds) and was conducted during a period of higher bond returns (higher interest rates) compared with current rates.
What the 4% rule doesn’t account for
Not to dismiss the diligent work of Bengen and the financial community that supported his conclusion, but, as with all pieces of conventional wisdom, the 4% rule doesn’t account for countless variables in each person’s individual situation. This is not so much the result of a failing in the rule itself, or the math that backs it up, but an inherent failing of attaching any firm, flat rule to governing long-term financial planning, given that the economic landscape over the long term is anything but flat and firm.