The Truth About The 4% Rule

4 minute read

The 4% rule has long been considered a “golden rule” for retirees: In the simplest sense, if you withdraw 4% of your investments in the first year of retirement and continue withdrawals each year (adjusting for inflation), you’ll have enough money to last you at least 30 years. But the problem is, how does this change during periods of high inflation, volatile markets, or recessions? And, while we’re at it, in today’s evolving economy and longer lifespans, is it even smart to follow traditional retirement rules of thumb?

For starters, it helps to have some historical perspective on the 4% rule itself, which comes straight from the trenches of financial planning. Almost exactly 30 years ago, a newly minted financial planner named Bill Bengen was trying to solve the problem of decumulation for his clients by giving them a “safe” amount they could withdraw each year for retirement. This amount would ensure they never outlived their money, even if they were hit by a worst-case financial scenario. As a proxy, he used 1968 – a year not unlike 2022 with dismal stock market returns coupled with high inflation – and found that as long as his clients capped the amount they withdrew at 4%, the money would last at least 30 years.

Don’t view rules of thumb as the final answer, but rather a place to begin a conversation

– David Blanchett

This rule has stood the test of time for decades, but in the past few years, it’s met some challenges. In late 2021, Morningstar published a paper suggesting that withdrawals should be capped at 3.3%. But in December 2022, the firm revised that number to 3.8%. (Morningstar Director of Personal Finance and Retirement Christine Benz has said the figure would be updated on a regular basis.) Bengen, too, took another pass at the rule, telling the hosts of the Bogleheads Live podcast that his own withdrawal rate is now 4.7%, though in periods of high inflation, 4.5% might be safer.

WATCH Your Money Map: the truth about the 4% rule

It’s enough to make a future retiree’s head spin: What’s the best way to parse all of this advice and apply it to your own situation? After all, we all want our money to last, while still achieving our bucket list dreams and living the retirement we want — and being able to sleep soundly at night. Thankfully, we have some answers. David Blanchett, Managing Director and Head of Retirement Research for PGIM DC Solutions and Research Fellow for the Alliance for Lifetime Income, and Margarita Perry, Senior Vice President and Financial Advisor at RBC Wealth Management, sat down with Alliance Education Fellow and HerMoney CEO Jean Chatzky to come up with these tips:

Understand the Meaning of “Rule of Thumb”

“Rules of thumb are not a terrible starting point,” Blanchett says, but they’re also not reality. Many models assume that people will take out the same amount of money year-in, and year-out, and if they withdraw a penny more than they should, their life will go off the rails. But that’s just not the way real life works. As a starting point for a withdrawal rate in retirement, 4% to 5% is pretty good, he acknowledges, but he cautions that “it’s not 8%, and it’s not 10%.” Once you decide on your starting point of around 4% to 5%, then you as an individual have to take a look at your assets and liabilities, whether or not you have pension income in addition to Social Security, and how much it costs to live your life.

Go Back to Your Budget

That last factor – the cost to live your life – is perhaps the most important piece of financial data in retirement, says Perry, and not enough people pay close attention to it.   “With all of my clients, I start with a wealth plan. That means knowing what’s coming in from all sources – and where it’s likely going to go.”

For example, “What are your needs? And what are your wants?” she asks. That will give you a sense of how much you’re able to spend on a consistent basis in order to make your money last.  “I have a lot of clients who come to me spending 8%,” she says.  “They don’t understand the long-term impact of [overspending, particularly if they’re doing it consistently].”

Don’t Underestimate Longevity Risk (Particularly for Women)

When Perry creates a wealth plan for her clients, she plans for them to live until they are 92 to 94. She’s playing the odds, she explains. When you have a 65-year-old couple, one of them has a 50% chance of living to 92, and a 25% chance of living to 98. For women, this planning is especially important, because they are likely to outlive their male spouses – and many don’t know how to handle it from a financial perspective.

According to the State of Women 2022 study from HerMoney and The Alliance for Lifetime Income, less than half of women (47%) know how to make their money last in retirement. All too often, women who may be intimidated by investing end up keeping too much money in a checking or basic savings account where they’re earning just ¼ of 1% on interest – or less. (If you’re worried your investing personality may be leading you to take too much risk or too little, this quiz can help you assess it.) Instead, Perry finds herself turning to one-year treasuries to make the most of that cash for now, and for the longer term, she looks to annuities that pay guaranteed income for life. This she’ll balance with enough money in equities to provide growth. (In other words, diversification!)

Advice Is Meant to Be Revisited

Most importantly, retirement planning is not a one-and-done experience. Perry, like many advisors, checks in with her clients about once a quarter. “My clients who have a plan, also have a process,” Perry says. “They have something in place. We’ve taken care of Plan B. So, they know they’re going to be okay.” She also notes that her calls with her clients are about far more than just running the numbers. “The best thing I could have for this job is a degree in psychology,” she says. And Blanchett agrees. “People left to their own devices can [fall prey] to human irrationality. They have a very bad sense of how long they’re going to live, when bad things are going to happen and how they’re going to deal. I believe the primary value of the advisor is to help you stay grounded over time.”

For more resources on how to make your income last and accomplish all your goals in retirement, visit the Tools and Guides section of the Alliance website.