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  • Mark Fonville, CFP®

Is the 4% Rule Really Best For Your Retirement Income Plan?


Is the 4% Rule Really Best For Your Retirement Income Plan?

Outliving a retirement nest egg is retirees’ #1 fear.

That’s understandable.

You have saved your entire working life to build it, and you know that the idea of going back to work in your golden years could be undesirable, or even impossible.


That makes withdrawal planning a critical aspect of your retirement portfolio.

Perhaps the most well-known withdrawal strategy is the 4% rule.


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In this article, we will look at how the 4% rule works and provide some guidance for you to consider if it is the best strategy to optimize your retirement savings.


We want to help make sure you enjoy retirement without outliving your money.


What's The 4% Rule?


An inherent problem in retirement planning is that you don’t know exactly how long you will live after you retire.


If you did, planning your retirement spending would be significantly easier because you’d know how many years your money needed to last.


But since that isn’t the case, we must incorporate that uncertainty into our withdrawal plans.


The 4% rule is one way of approaching this variable. It is based on a comprehensive retirement withdrawal study conducted by William Bengen in 1994.

Bengen wanted to know was how much a retiree could plan to withdraw each year, as a percentage of their portfolio, without running out of money (regardless of the unknown future performance of markets or the economy).

We’ll spare you the gritty details, but essentially what Mr. Bengen discovered was that historically, there was not a single 30-year period in which a retiree would have depleted their portfolio (if managed prudently) if they withdrew 4% in the first year of retirement and adjusted their withdrawal for inflation every year after.

Thus, the “4% rule” has become a staple of retirement income planning as a safe withdrawal rate, and many retirees use it as a starting point.


As an example, suppose a retiree has a $1,000,000 nest egg. In the first year of retirement, their initial withdrawal is $40,000. If the inflation rate for the year is 3%, then the next year’s withdrawal would be $41,200.



Critical Limitations of the 4% Rule


Now that you’re familiar with the basics of the 4% rule, it’s time to dig a little deeper to point out where the study falls short in practice.

While the study is valid, it's just a rule of thumb based on a specific set of factors.

It’s important to be aware of these parameters because you may need or want to adjust your own withdrawal plan and planned withdrawal rate based on how your situation differs from the study’s assumptions.


The 4% rule doesn't consider other sources of income


Most people will have several retirement accounts as well as other income sources. Social Security benefits are the most common, but you may also have IRAs, real estate, part-time employment, annuity, or another pension.


With these other sources of income, do you need to withdraw 4%? In some years you may need to withdraw much more and in others much less.


The 4% rule is based on a 30-year retirement horizon.


Perhaps the most glaring aspect of the study is that it assumes a 30-year retirement. Your family history, personal health, life expectancy, and age at which you retire weigh heavily on how long you will live in retirement and should be considered in your withdrawal plan.