Four Percent Rule

What Is the Four Percent Rule?

The Four Percent Rule is a rule of thumb used to determine how much a retiree should withdraw from a retirement account each year. This rule seeks to provide a steady income stream to the retiree while also maintaining an account balance that keeps income flowing through retirement. Experts are divided on whether the 4% withdrawal rate is safe, as the withdrawals will consist primarily of interest and dividends.

Understanding the Four Percent Rule

The Four Percent Rule helps financial planners and retirees set a portfolio's withdrawal rate. Life expectancy plays an important role in determining if this rate will be sustainable, as retirees who live longer need their portfolios to last longer, and medical costs and other expenses can increase as retirees age.

History of the Four Percent Rule

The Four Percent Rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976. Before the early 1990s, experts generally considered 5% to be a safe amount for retirees to withdraw each year.

Skeptical of whether this amount was sufficient, financial advisor William Bengen conducted an exhaustive study of historical returns in 1994, focusing heavily on the severe market downturns of the 1930s and early 1970s. Bengen concluded that, even during untenable markets, no historical case existed in which a four percent annual withdrawal exhausted a retirement portfolio in less than 33 years.

Accounting for Inflation

While some retirees who adhere to the Four Percent Rule keep their withdrawal rate constant, the rule allows retirees to increase the rate to keep pace with inflation. Possible ways to adjust for inflation include setting a flat annual increase of 2% per year, which is the Federal Reserve's target inflation rate, or adjusting withdrawals based on actual inflation rates. The former method provides steady and predictable increases, while the latter method more effectively matches income to cost-of-living changes.

While the Four Percent Rule recommends maintaining a balanced portfolio of 50% common stocks and 50% immediate-term Treasurys, some financial experts advise maintaining a different allocation, including reducing exposure to stocks in retirement in favor of a mix of cash, bonds, and stock.

Advantages and Disadvantages of the Four Percent Rule

While following the Four Percent Rule can make it more likely that your retirement savings will last the remainder of your life, it doesn’t guarantee it. The rule is based on the past performance of the markets, so it doesn't necessarily predict the future. What was considered a safe investment strategy in the past may not be a safe investment strategy in the future if market conditions change.

There are several scenarios in which the Four Percent Rule might not work for a retiree. A severe or protracted market downturn can erode the value of a high-risk investment vehicle much faster than it can a typical retirement portfolio.

Furthermore, the Four Percent Rule does not work unless a retiree remains loyal to it year in and year out. Violating the rule one year to splurge on a major purchase can have severe consequences down the road, as this reduces the principal, which directly impacts the compound interest that the retiree depends on for sustainability.

However, there are obvious benefits to the Four Percent Rule. It is simple to follow and provides for predictable, steady income. And, if it is successful, the Four Percent Rule will protect you from running short of funds in retirement.

What We Like

What We Don't Like

The Four Percent Rule and Economic Crises

Actually, the Four Percent Rule may be a little on the conservative side. According to Michael Kitces, an investment planner, it was developed to take into account the worst economic situations, such as 1929, and has held up well for those who retired during the two most recent financial crises. Kitces points out:

The 2000 retiree is merely "in line" with the 1929 retiree, and doing better than the rest. And the 2008 retiree — even having started with the global financial crisis out of the gate — is already doing far better than any of these historical scenarios! In other words, while the tech crash and especially the global financial crisis were scary, they still haven’t been the kind of scenarios that spell outright doom for the Four Percent Rule.

This is, of course, not a reason to go beyond it. Safety is a key element for retirees, even if following it may leave those who retire in calmer economic times "with a huge amount of money left over," Kitces notes, adding that "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% Rule FAQs

Does the 4% Rule Still Work?

Not only is the Four Percent Rule outdated, but it also doesn't account for changing market conditions. It's important to keep in mind that following the rule doesn't guarantee you won't run short of funds. In addition, the rule was developed when bond interest rates were much higher than they are now. 

How Long Will My Money Last Using the 4% Rule?

The Four Percent Rule is intended to make your retirement savings last for 30 years (or more).

Does the 4% Rule Work for Early Retirement?

The Four Percent Rule is focused on a traditional, 30-year retirement. So, the rule is valid for those retiring at 65 or older.

How Long Will $500,000 Last in Retirement?

It depends on how much money you withdraw each year. If you have saved $500,000 for retirement and you withdraw $20,000 per year, this amount will last you approximately 25 years.

What Is a 4% Rule Calculator?

The Four Percent Rule calculator is the retirement calculator for the Four Percent Rule. It can help you calculate the savings required to withdraw a specified annual income.

The Bottom Line

For most people, managing their retirement savings is a balancing act. If they withdraw too much too fast, they'll risk running out of money. On the flip side, not withdrawing enough money can mean they don't get the full benefit of their hard-earned savings.

For those that want a rule of thumb to follow, the Four Percent Rule can be an easy way for many retirees to manage their withdrawals in retirement.