This popular rule of thumb is just too simple to rely on for all of your retirement planning.
Since the mid-1990s, the 4% rule has been a gold standard in retirement planning. Its simplicity is the key to its appeal because it helps answer a challenging and complex question: How much can you spend each year in retirement?
While the 4% rule is a great starting point for your retirement planning, it's flawed as a stand-alone strategy because its simplicity leaves too much room for error. The reality is the market and economy are volatile at times, which creates blind spots that could get retirees in trouble.
Here's how you can tweak the rule to improve it and ensure your retirement goes according to plan.
What is the 4% rule?
William Bengen, a retired financial advisor, created the rule as a "North Star" for retirement savings. Bengen based it on historical investment data related to stock and bond market performance from 1926 to 1976. The goal of the rule is to make sure people can stretch their retirement savings for as long as needed without the risk of running out of money.
The 4% rule is wonderfully simple. It states that an investor can withdraw 4% annually (adjusted for inflation) from a portfolio of 60% stocks and 40% bonds, and expect their savings to last at least 30 years. For example, consider a $1 million nest egg. John or Jane Doe should be able to withdraw $40,000 in year one. If inflation ends up being 3% that year, they would withdraw $41,200 in year two, and so forth.
It's understandable why it became such a popular rule: It helps retirees grapple with a very complex topic and is strikingly easy to implement. But its ease of use has resulted in people depending on the rule as a stand-alone retirement strategy, and unfortunately, it's just not that simple.
What are its flaws?
For starters, the market can be very volatile from year to year, which can cause uneven withdrawals. For example, suppose you withdraw $40,000 from that $1 million portfolio in year one. However, in addition to your withdrawal, the market experiences a sharp downturn, and your portfolio value falls 30% to about $670,000. That $41,200 you withdraw in year two (adjusted for the 3% inflation) takes a 6.1% bite out of your nest egg. Meanwhile, there's no way to know how long the market will take to bottom out or recover.
The opposite can also happen: Your portfolio keeps growing, and your fixed amounts can leave too much on the table. You might not want to reach the end of your life with a ton of money left over that you could have enjoyed had you been a bit more aggressive with your withdrawals.
This is especially relevant as the elderly face surging healthcare and assisted-living costs. These expenses are growing far faster than overall inflation. Left unchecked, your quality of life can deteriorate as these expenses consume an increasingly significant portion of your annual income.
Add a little flexibility to your plans
One solution is to put a cap and floor on what your annual withdrawal can represent as a portion of your portfolio. For example, consider using the 4% rule to find a baseline number. Each year, calculate what that baseline withdrawal will represent as a percentage of your portfolio value at the time.
Think back to the previous example where a market crash caused the baseline number to represent a 6.1% withdrawal. A 5% cap might temporarily restrict your income for that year, but it would also protect your nest egg from drying up ahead of schedule.
Conversely, you would withdraw more in an up-year for your portfolio, giving you a financial buffer and preventing a prolonged bull market from leaving too much of your portfolio on the table over time. The good news is bull markets historically last longer than bear markets, so you're more likely to end up with a surplus any given year than having to tighten your belt.
The 4% rule is a solid starting point, but getting the most out of your retirement will require more planning and flexibility. Don't hesitate to consult a professional advisor for specific advice and planning strategies for your situation.
FAQs
Here's What You Should Really Be Looking at During Retirement. "Withdraw 4% of your savings your first year of retirement, adjust subsequent withdrawals for inflation, and you should be golden." Such is the advice many retirees have followed for decades in an effort to avoid running out of money.
Should you break the 4% retirement rule? ›
Retirees who are depending on their savings to fund essential expenses would want to have a conservative approach. However, those who have can withstand more market fluctuations may have more flexibility with withdrawal rates. For those retirees, the 4% rule likely will provide an outdated recommendation.
What is the Morningstar 4% rule for retirement? ›
The 4% rule suggests that retirees can safely withdraw 4% of their portfolio in the first year of retirement and then adjust that amount annually for inflation over the course of at least 30 years without having to worry about ever running out of money.
Which is the biggest expense for most retirees? ›
Housing—which includes mortgage, rent, property tax, insurance, maintenance and repair costs—is the largest expense for retirees. More specifically, the average retiree household pays an average of $17,472 per year ($1,456 per month) on housing expenses, representing almost 35% of annual expenditures.
Is $4 million enough to retire at 62? ›
In all likelihood, $4 million will be more than enough for you as a retiree, and you'll be able to pass a good amount on to your beneficiaries. But, if you need to save even more, know that your existing lump sum can do much of the work for you, if invested correctly.
What is the $1000 a month rule for retirement? ›
One example is the $1,000/month rule. Created by Wes Moss, a Certified Financial Planner, this strategy helps individuals visualize how much savings they should have in retirement. According to Moss, you should plan to have $240,000 saved for every $1,000 of disposable income in retirement.
How long will $400,000 last in retirement? ›
This money will need to last around 40 years to comfortably ensure that you won't outlive your savings. This means you can probably boost your total withdrawals (principal and yield) to around $20,000 per year. This will give you a pre-tax income of almost $36,000 per year.
What is the Biden retirement rule? ›
Retirement investors can now trust that their investment advice provider is working in their best interest and helping to make unbiased decisions.” The rule aligns with the Biden-Harris administration's effort to protect retirement investors and put more money into the pockets of workers and their families.
How long will $500,000 last in retirement? ›
Summary. If you withdraw $20,000 from the age of 60, $500k will last for over 30 years. Retirement plans, annuities and Social Security benefits should all be considered when planning your future finances. You can retire at 50 with $500k, but it will take a lot of planning and some savvy decision-making.
What is the golden rule for retirement? ›
The golden rule of saving 15% of your pre-tax income for retirement serves as a starting point, but individual circ*mstances and factors must also be considered.
Among the biggest mistakes retirees make is not adjusting their expenses to their new budget in retirement. Those who have worked for many years need to realize that dining out, clothing and entertainment expenses should be reduced because they are no longer earning the same amount of money as they were while working.
How much does the average 70 year old have in retirement funds? ›
The average amount of retirement savings for 70-year-olds is $113,900, according to our 2023 Planning & Progress survey.
At what age should you have $1 million in retirement? ›
Based on this, if you retire at age 65 and live until you turn 84, $1 million will probably be enough retirement savings for you. However, it's important to remember there is no one-size-fits-all amount.
What percentage of retirees have a million dollars? ›
If you have more than $1 million saved in retirement accounts, you are in the top 3% of retirees. According to EBRI estimates based on the latest Federal Reserve Survey of Consumer Finances, 3.2% of retirees have over $1 million in their retirement accounts, while just 0.1% have $5 million or more.
What is the magic number to retire? ›
When it comes to retirement, Americans have a new number in mind — $1.46 million — for how much they think they will need to live comfortably, according to new research from Northwestern Mutual.
Is the 4% retirement rule making a comeback? ›
Thanks to higher interest rates and bond yields, it is likely safe for new retirees to spend 4% of their nest eggs in their first year of retirement and then to adjust that amount for inflation in subsequent years, according to a new analysis from Morningstar released Monday.
How long will money last using the 4% rule? ›
This rule is based on research finding that if you invested at least 50% of your money in stocks and the rest in bonds, you'd have a strong likelihood of being able to withdraw an inflation-adjusted 4% of your nest egg every year for 30 years (and possibly longer, depending on your investment return over that time).
How many people have $1,000,000 in retirement savings? ›
According to the Federal Reserve's latest Survey of Consumer Finances, only about 10% of American retirees have managed to save $1 million or more.
