What Is The 4% Rule For Retirement Withdrawals? (2024)

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It’s a question on the minds of those in retirement or nearing retirement. How much of your nest egg can you spend each year without running out of money in retirement? In 1994, financial advisor William Bengen published a paper that answered this very question.

His paper—Determining Withdrawal Rates Using Historical Data—was published in the Journal of Financial Planning. Bengen found that retirees could safely spend about 4% of their retirement savings in the first year of retirement. In subsequent years, they could adjust the annual withdraws by the rate of inflation.

Following this simple formula, Bengen found that most retirement portfolios would last at least 30 years. In many cases the portfolios remained intact for 50 years or more. As simple as the 4% Rule is, many either misapply it or fail to appreciate some of the underlying assumptions in Bengen’s work.

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How the 4% Rule Works

The 4% rule is easy to follow. In the first year of retirement, you can withdraw up to 4% of your portfolio’s value. If you have $1 million saved for retirement, for example, you could spend $40,000 in the first year of retirement following the 4% rule.

Beginning in year two of retirement, you adjust this amount by the rate of inflation. If inflation were 2%, for example, you could withdraw $40,800 ($40,000 x 1.02). In the rare case where prices went down by say 2%, you would withdraw less than the previous year—$39,200 in our example ($40,000 x 0.98). In year three, you’d take the prior year’s allowed withdrawal, and then adjust that amount for inflation.

One common misconception is that the 4% rule dictates that retirees withdraw 4% of their portfolio’s value each year during retirement. The 4% applies only in year one of retirement. After that inflation dictates the amount withdrawn. The goal is to maintain the purchasing power of the 4% withdrawn in the first year of retirement.

How Bengen Tested the 4% Rule

Bengen looked at retirements beginning over a 50-year period from 1926 to 1976. He used actual market returns from 1926 through 1992. For years beginning in 1993, he assumed a 10.3% return on stocks and a 5.2% return on bonds. Withdrawals were made at the end of each year and the portfolio rebalanced annually.

From this he evaluated the longevity of the portfolio for up to 50 years. For example, he examined whether a portfolio of someone retiring in 1926 would last until 1976. For those retiring in 1976, he examined whether their portfolio would last until 2026.

While Bengen didn’t coin the phrase “the 4% rule,” it comes from the results he documented. What he found was that an initial withdrawal rate of 4% enabled most portfolios to last 50 years or more. And for those that fell short, they still lasted about 35 years or longer, more than enough for the majority of retirees.

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Deconstructing the 4% Rule

There are a number of underlying assumptions behind the 4% rule that are important to understand. The rule rests on precise asset allocation constraints, while fees, inflation and sequence of returns risk can lead to varying outcomes when following the 4% rule.

Asset Allocation

After testing various asset allocations, Bengen adopted the assumption that a retiree’s portfolio would be invested 50% in stocks () and 50% in bonds (intermediate term Treasuries). Using this asset allocation, he tested a range of first-year withdrawal rates:

• 3% withdrawal rate: All portfolios lasted 50 years.

• 4% withdrawal rate: Most portfolios lasted 50 years. Retirements started in 10 of the 50 years examined fell short of this mark, although they all lasted about 35 years or longer.

• 5% withdrawal rate: More than half of the portfolios were exhausted in less than 50 years, with the worst portfolios lasting no more than about 20 years.

• 6% withdrawal rate: Only seven portfolios lasted 50 years, with about 10 lasting fewer than 20 years.

When examining other asset allocations, Bengen found that holding too few stocks did more harm than holding too many. Portfolios with 0% to 25% allocated to equities saw their longevity severely compromised. He also found that the 50/50 allocation was optimal if the only goal was portfolio longevity.

If a retiree also wanted a secondary goal of wealth creation, Bengen advised increasing the stock allocation to as close to 75% as possible. For some retirees, a 50/50 portfolio is a level of risk that’s hard to stomach, making an allocation to stocks of 75% an even bigger risk hurdle. Nevertheless, the 4% rule as Bengen documented it requires a stock allocation of 50% to 75%.

The Impact of Fees

Bengen did not take into account the potential for investment management fees to reduce returns over the life of a portfolio. For those who manage their own investments in low-cost index funds, the minuscule fees they pay shouldn’t affect Bengen’s results. For those who pay an investment advisor, however, the 4% rule may not apply.

It’s not uncommon for an investment advisor to charge an annual fee of 1% of assets under management. If the advisor chooses actively managed mutual funds, which typically charge 75 basis points or more per year, total fees can approach or even exceed 2%. The impact of high investment management fees on portfolio returns would certainly compromise the 4% rule.

Sequence of Returns Risk

For the purposes of the 4% rule, sequence of returns riskis the possibility that adverse market returns in the early years of retirement could deplete a portfolio well before 30 years pass. Alternatively, sequence of returns can substantially increase a portfolio value if one happens to retire at the start of a bull market, leaving a retiree who follows the rule with a sizable balance even after 30 years.

The main challenge for retirees, whichever strategy they choose, is that you can’t predict the future performance of markets. A person retiring in January 1929 would have no idea that an historic stock market crash ushering in the Great Depression was just 10 months away. Likewise, a person retiring in January 2009 wouldn’t know that the market bottom was just three months away, followed by one of the longest bull markets in history.

The good news is that Bengen’s work considered the downside risk of sequence of returns. By analyzing actual market data beginning in 1926, his results considered retirees who entered retirement during or just before some very difficult markets, including:

• 1929 to 1931: Stocks down 61.0%

• 1973 to 1974: Stocks down 37.2%

• 1937 to 1941: Stocks down 33.3%

Notwithstanding these market declines, retirees starting retirement in or just before these years saw their portfolios survive for at least 30 years when following the 4% rule.

Inflation Impacts

Looking at the above bear markets, one might suspect that the period 1929 to 1931 would be the most challenging for retirees. It turns out not to be the case.

Using the 4% rule, those who retired in or near 1929 saw their portfolios survive a full 50 years. Those retiring near the 1937 to 1941 market didn’t fare as well, with the first three years seeing portfolio longevity fall to around 40 years. But it was those retiring in the years leading up to the 1973 to 1974 market that suffered the most. Why?

In a word—inflation. The period 1973 to 1974 saw prices rise by 22.1%. As a result, retirees had to substantially increase their annual withdrawals just to maintain the same standard of living. In contrast, 1929 to 1931 experienced deflation, with prices falling 15.8% during that period. While retirees experience significant declines in their portfolios, they could also reduce the amount of the annual withdrawals during this time and still maintain the purchasing power of their money.

Dynamic Withdrawal Rates

The 4% rule assumes a rigid withdrawal rate throughout retirement. Retirees take out 4% in the first year of retirement. After that, they adjust their annual withdrawals by the rate of inflation (or deflation). As Bengen noted in his paper, however, dynamic withdrawals give retirees significant flexibility.

For example, a retiree might reduce their annual withdrawal by 5% in the midst of a bear market or unexpectedly high inflation. While a 5% reduction may not seem significant, it can substantially improve a portfolio’s longevity.

Is the 4% Rule Still Valid?

In recent years, some have questioned whether the 4% rule remains valid. They point to low expected returns from stocks given high valuations. They also point to low yields on fixed income securities. While both concerns are real, the 4% rule has been proven reliable through a wide range of difficult markets.

As noted above, Bengen’s analysis of the 4% rule has stood up to the stock market crash of 1929, the Great Depression, World War II and the stagflation of the 1970s. While none of us knows the future, history strongly suggests that the 4% rule is a reliable approach to determining how much one can spend in retirement.

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What Is The 4% Rule For Retirement Withdrawals? (2024)

FAQs

What Is The 4% Rule For Retirement Withdrawals? ›

The 4% rule limits annual withdrawals from your retirement accounts to 4% of the total balance in your first year of retirement. That means if you retire with $1 million saved, you'd take out $40,000. According to the rule, this amount is safe enough that you won't risk running out of money during a 30-year retirement.

Does the 4% withdrawal rule for retirees still make sense? ›

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.

How do you calculate the 4% retirement rule? ›

4% rule calculation. Start by adding up all your investments, retirement accounts, and residual income. Calculate 4% of that total, and that's the budget for your first year of retirement. After each year, you adjust for inflation.

How long will money last using the 4% rule? ›

But, if you're already retired or older than 65, your planning time horizon may be different. The 4% rule, in other words, may not suit your situation. It includes a very high level of confidence that your portfolio will last for a 30-year period.

What works better than the 4% retirement rule? ›

A better approach could be to customize your portfolio withdrawal rates based on individual factors. A slew of recent studies try do that—tailoring spending estimates to things like a person's financial flexibility, health, and ownership of guaranteed-income products such as annuities.

What is the $1000 a month rule for retirement? ›

According to the $1,000 per month rule, retirees can receive $1,000 per month if they withdraw 5% annually for every $240,000 they have set aside. For example, if you aim to take out $2,000 per month, you'll need to set aside $480,000. For $3,000 per month, you would need to save $720,000, and so on.

What is a safe withdrawal rate for a 70 year old? ›

As a rule of thumb, many retirees use 4% as their safe withdrawal rate—the so-called 4% rule. The 4% rule states that you withdraw no more than 4% of your starting balance each year in retirement, adjusted each year for inflation.

What is a good monthly retirement income? ›

The ideal monthly retirement income for a couple differs for everyone. It depends on your personal preferences, past accomplishments, and retirement plans. Some valuable perspective can be found in the 2022 US Census Bureau's median income for couples 65 and over: $76,490 annually or about $6,374 monthly.

At what age is 401k withdrawal tax free? ›

Employer-sponsored, tax-deferred retirement plans like 401(k)s and 403(b)s have rules about when you can access your funds. As a general rule, if you withdraw funds before age 59 ½, you'll trigger an IRS tax penalty of 10%.

How long will $1 million last in retirement? ›

For example, if you have retirement savings of $1 million, the 4% rule says that you can safely withdraw $40,000 per year during the first year — increasing this number for inflation each subsequent year — without running out of money within the next 30 years.

What are the flaws of the 4% rule? ›

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.

How many people have $1,000,000 in retirement savings? ›

The Reality of Million-Dollar Retirements

According to estimates based on the Federal Reserve Survey of Consumer Finances, only 3.2% of retirees have over $1 million in their retirement accounts. This percentage drops even further when considering those with $5 million or more, accounting for a mere 0.1% of retirees.

What percentage of retirees have $3 million dollars? ›

The Employee Benefit Research Institute (EBRI) estimates that 3.2% of retirees have over $1 million, and a mere 0.1% have $5 million or more, based on data from the Federal Reserve Survey of Consumer Finances. 2. What is the estimated amount of money needed to retire at age 60?

Why the 4 rule no longer works for retirees? ›

The 4% rule comes with a major caveat: It's not really a “rule” since everyone's situation is different. If you have a large retirement investment portfolio, you might not need to spend 4% of it every year. If you have limited savings, 4% might not come close to covering your needs.

What is the best withdrawal strategy for retirement? ›

The 4% rule is a strategy that says you should withdraw 4% of your retirement savings in your first year of retirement. In subsequent years, tack on an additional 2% to adjust for inflation. For example, if you have $1 million saved under this strategy, you would withdraw $40,000 during your first year in retirement.

How much money do you need to retire with $100,000 a year income? ›

To cut to the chase, if you want your interest to earn $50,000, $70,000 or $100,000 per year, you'll need to have approximately $1.25 million to $2.5 million in savings or retirement accounts. If you're aiming for somewhere in the middle, like $70,000, you'd want to have $1.75 million saved.

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.

What is the new retirement withdrawal rule? ›

Since January, penalty-free withdrawals of up to $1,000 have been allowed for personal emergencies, under the SECURE Act 2.0, which made other significant changes to retirement plans.

What percentage of retirees have $4 million dollars? ›

As mentioned, $1 million in tax-advantaged retirement accounts will put you in the top 3% of retirement savers. As far as net worth is concerned, estimates that use the same data from the Federal Reserve survey have found that a net worth of $4.64 million would put you in the top 3% of American households.

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