What’s the Four Percent Rule?
The Four Percent Rule might help retirees decide how much to withdraw each year.
The guideline ensures a continuous revenue stream and a sufficient account balance for future years. The withdrawals will mostly be interest and profits from savings.
Experts disagree on whether a 4% withdrawal is ideal. The rule’s inventor and others argue that 5% is preferable for everything except the worst-case situation. Some suggest that 3% is safer under present interest-rate conditions.
Knowing the Four Percent Rule
Some financial advisors and retirees estimate a pleasant but safe retirement income using the 4% Rule.
Life expectancy is crucial in establishing the sustainability of a rate. Longer-lived retirees demand longer-lasting portfolios and higher medical and other costs.
History of the Four Percent Rule
Bill Bengen, a Southern California financial planner, invented the 4% Rule in the mid-1990s. However, some advocates dispute its oversimplification. He claimed 5% was more feasible than 4%, which was a “worst-case” situation.
The rule was based on stock and bond returns from 1926 to 1976, emphasizing the severe 1930s and early 1970s market downturns.
Bengen found no historical example of a 4% annual withdrawal exhausting a retirement account in less than 33 years, even in unsustainable markets.
Accounting for Inflation
The 4% rule permits retirees to adjust their withdrawal rate to keep up with inflation, while others maintain a constant rate. One option to account for inflation is establishing a 2% yearly increase, which is the Federal Reserve’s aim, or modifying withdrawals depending on actual inflation rates. The former strategy offers consistent gains, while the latter better aligns income with cost-of-living fluctuations.
The 4% Rule advocates a balanced portfolio of 50% common stocks and 50% intermediate-term Treasury bonds; however, some financial gurus propose a combination of cash, bonds, and stocks in retirement.
Pros and Cons of the Four Percent Rule
The 4% rule can increase the likelihood that your retirement funds will last a lifetime, but it doesn’t guarantee it. The rule predicts market success based on historical performance, not the future. If market conditions change, a safe investing approach may no longer be safe.
There are various reasons the 4% rule may not work for retirees. A severe or prolonged market slump can devalue high-risk investments quicker than retirement portfolios.
The 4% Rule only works if retirees follow it year after year. Violating the guideline of one year to buy an oversized item diminishes the principal, which affects compound interest, which the retiree needs for sustainability.
The 4% Rule has clear benefits. It is easy to follow and generates regular money. If effective, the 4% Rule will prevent retirement fund depletion.
- Very easy to follow.
- Income is consistent and predictable
- Prevents retirement money shortages
- It doesn’t adapt to lifestyle changes and requires careful commitment.
- Based on ‘worst-case’ portfolio performance
- 5% may be more plausible than 4%.
The 4% Rule and Economic Crisis
The 4% Rule may be too cautious. Michael Kitces, an investment advisor, says it was designed for the worst economic times, like 1929, and has held up well for retirees during the two most recent financial crises. Kitces notes:
The 2000 retiree is “in line” with the 1929 retiree, outperforming others. Despite starting with the global financial crisis, the 2008 retiree has exceeded all previous projections. Thus, while the tech crash and global financial crisis were alarming, they did not destroy the 4% Rule.
This does not justify going further. Retirees need safety, even if it leaves them “with a huge amount of money left over,” Kitces says. “In general, a 4% withdrawal rate is really quite modest relative to the long-term historical average return of almost 8% on a balanced (60/40) portfolio!”4
According to some analysts, recent low interest rates on bonds and savings imply a safer withdrawal rate of 3%. The ideal approach is to discuss your savings, assets, and retirement plans with a financial advisor.
Is the 4% rule valid?
Even in a lengthy market slump, the 4% rule covered retirees’ financial demands. Many financial experts claim that 5% offers a more comfortable life with a small additional risk.
How Long Will My Money Will Last With the 4% Rule?
The 4% Rule aims to extend retirement savings to 30 years.
Is the 4% rule good for early retirement?
The 4% Rule prepares for retirement at 65. If you plan to retire early or work past 65, your long-term financial demands will change.
What is the 4% Rule Calculator?
Use any online retirement withdrawal calculator to calculate your yearly withdrawal using the 4% guideline. You may find an example at My Calculators.
Retirement savings management is a balance for most people. Withdrawing too much too rapidly might deplete their funds. Not withdrawing enough funds might limit the value of their savings.
The 4% Rule is a simple rule of thumb.
Correction—Jan. 20, 2022: A balanced stock-bond portfolio did not contain the kind of bonds in an earlier version of this article. Intermediate-term Treasury bonds, not immediate-term
- The 4% Rule indicates a retiree’s annual savings withdrawal.
- The regulation aims to provide retirees with a regular and secure income stream for their current and future needs.
- The rule is based on historical stock and bond returns from 1926 to 1976. With current interest rates, some experts recommend 3% withdrawals, while others recommend 5%.
- Life expectancy affects sustainable rates.