If you’re a client of ours, you’ve heard me bring up the 4% Rule as a frame of reference. If you’ve done any retirement research, you’ve probably come across it in your reading, as well. And while it’s one of the most widely cited guidelines in retirement planning (for good reason), there’s also more nuance to it than many headlines suggest. Let’s dive in!
When sitting down with a client to map out their retirement plans, one of the earliest questions that I’maskedis “How much can I safely spend each year without running out of money?”. Insert a preliminary discussion of the 4% rule which I use as an educational starting point to frame the concept of sustainability and prudence.
So, what IS the 4% rule?
The 4% Rule originated from research conducted in the 1990s that examined historical market returns. The idea was straightforward:In your first year of retirement, withdraw 4% of your investment portfolio. Then, increase that dollar amount each year to keep pace with inflation.
For example, if you retire with a $1,000,000 portfolio: You’d withdraw $40,000. And every year there on, you’d take 4%of whatever the overall balance was.Historically, this strategy has had a high probability of lasting for a 30-year retirement when invested in a diversified portfolio of stocks and bonds.
Why It Became So Popular
The 4% Rule gained popularity because it offered something retirees desperately wanted: a simple framework.Rather than guessing how much to spend, retirees had a benchmark that balanced enjoying retirement today while preserving assets for the future.It's easy to understand and easy to calculate.
But retirement today looks different than itdidwhen the rule was first developed.
The Limitations of the 4% Rule
While the 4% Rule remains a useful starting point, it shouldn't be viewed as a one-size-fits-all solution.
Markets Don't Follow Historical Averages
The original research relied on historical U.S. market performance. Future returns may look different, especially during periods of lower expected investment returns or prolonged inflation.It might make sense to take less than 4% in years when there are sequential negative returns. Alternatively, when portfolio returns far exceed 4%, it’s acceptable to take a bit extra and enjoy the additional money– in fact, I often encourage that.Flexibility isreally importanthere, but not without caution. Which brings me to my next point.
Spending Isn't Constant
The 4% Rule assumes retirees spend essentially the same amount (adjusted for inflation) every year.In reality, spendingtends to fluctuate. However, while spending naturallyebbsandflowsyear to year, I do caution clients from relying solely on market performance to dictate whether they take that vacation or send money to the kids. I think this is where the 4% rule isactually helpful, because it gives us an anchor to workfrom. Imagine feeling like you can only take that once in a lifetime trip depending on if the market is up? That’s the antithesis of what I try to stress with clients when aiming to find a peacefuland unattached relationship with cyclical market movement.
Retirement Isn't Always 30 Years
Many people are retiring earlier and living longer.A retirementlasting 35 or even 40 years requires a different strategy than one lasting 30 years.
Income Sources Matter
Your investment portfolio is only one piece of the puzzle.
Factors like:
Social Security
Pensions
Rental income
Part-time work
Required Minimum Distributions (RMDs)
Taxes
allinfluence how much youactually needto withdraw from investments.
A More Flexible Approach
Rather than treating 4% as a rule carved in stone,I like to incorporate it as an educational data point. A comprehensive retirement income strategyconsiders:what you need to spend to meet your needs, what youwantto spend,tax-efficient withdrawal strategies, the investment risk you’re willing and able to take, your age at retirement, healthcare costs,and legacy goals to name a few.
In some years, it may make sense to withdraw less than 4%. In others, withdrawing more may be perfectly reasonable if your overall financial plan supports it.Flexibilitycanlead to better long-term outcomes than rigidly following a singlepercentagehowever, having stability in income is important.
So... Is 4% Still a Good Rule?
The answer is yes,as long asyou leave room for flexibility.The 4% Rule is an excellent starting point for estimating retirement income, but it isn't a personalized retirement planand is something we analyze with clients every single year.Two retirees with identical portfolio balances may need very different withdrawal strategies depending on their taxes, spending needs, longevity, risk tolerance, and financial goals.The goal isn't to die with the largest portfolio possible. Nor is it to spend too freely andthenworry about running out of moneyin our old age.
We find that for many of our clients the goal isconfidence—knowing you can spend in retirement in a way that supports the life you want while maintaining financial security for years to comewithoutletting external factors like market conditions dictate your ability to live and spend how you want.That's where thoughtful planning can make all the difference.
Want to know more about how toseparate sustainable spending from market volatility? See my post on sequence of returns in our blog section!