How the 4 Percent Rule Works in Retirement

The 4 percent rule is based on the idea that you should only withdraw 4% of your portfolio each year of your retirement.

Michael Schultheiss

Published July 31st, 2020

Updated December 14th, 2020

Key Takeaways

  • The 4 percent rule is based on the idea that you should only withdraw 4% of your portfolio each year of your retirement.
  • There is a strong case that the rule is very conservative.
  • The 4 Percent Rule is at best a general guideline, and you should talk to a Certified Financial Planner® for a better, more precise retirement withdrawal rate.

The 4 Percent Rule has long been influential in retirement planning. The idea is that you should only withdraw 4% of your portfolio for each year of your retirement, assuming that your portfolio allocation was 50% stocks and 50% bonds.

In other words, if you have $100,000 at the time of retirement, following the 4 Percent Rule would mean withdrawing about $4,000 the first year of retirement. The rule allows for increases with inflation. Following the 4 Percent Rule, the idea is that your money should last for 30 years.

What is the 4 Percent Rule?

If you have ever done looking for the “correct” retirement withdrawal rate, you may have seen suggested searches such as “4 rule retirement,” “rule of four definition,” “what is the 4 rule” and “what is the rule of 4.” All of these questions are concerned with the 4 Percent Rule, the idea that so long as you withdraw no more than 4% from your portfolio every year of your retirement, you’ll be fine.

There’s one problem with the 4 Percent Rule, though, and it has to do with the history of the rule and where it came from.

Where the 4 Percent Rule Came From

The 4 Percent Rule started to become popular among retirement planners after the 1998 publication of the paper Retirement Savings: Choosing a Withdrawal Rate that is Sustainable, authored by three professors at Trinity University.

Because the authors of the study all taught at Trinity, the study is sometimes known as the Trinity Study.

Ironically, the 4 percent rule seems to have arisen as a rather significant misunderstanding of the conclusions of the Trinity Study. Some of the conclusions the authors of the Trinity Study reached include the following:

"Most retirees would likely benefit from allocating at least 50 percent to common stocks."

"Retirees who demand CPI-adjusted withdrawals during their retirement years must accept a substantially reduced withdrawal rate from the initial portfolio."

"For stock-dominated portfolios, withdrawal rates of 3 percent and 4 percent represent exceedingly conservative behavior."

This is where the “rule of 4” or “4 percent rule” came from. How well has it held up since?

Debating the 4 Percent Rule

The 4 Percent Rule has sparked plenty of analysis, discussion, and debate since the publication of the Trinity Study.

Some criticisms of the 4 Percent Rule include the observation that the original Trinity study does not incorporate mutual fund fees, the fact that the Rule has not held up nearly as well in most other developed countries, and the fact that the study considers retirement lengths up to 30 years but not beyond.

On the other hand, there is a good case that the 4 Percent Rule is still a little on the conservative side. Investment planner Michael Kitces has explained that the 4 Percent Rule was designed in light of data from the worst economic situations in recent history, including the crash of 1929 that inaugurated the Great Depression.

Because of this, the rule is a very conservative estimate. While it is a good idea to talk to a Certified Financial Planner® to get a sense of what your best option for a withdrawal rate is, you will probably not have to be as conservative as 4%.

With this in mind, are there any drawbacks of the 4 Percent Rule?

Potential Drawbacks of the 4 Percent Rule

One potential drawback of the 4 Percent Rule is considering it an actual rule as opposed to a guideline. A rule is meant to be adhered to. A guideline is more of an informed suggestion.

To get a sense of why the difference between a rule and a guideline matters, consider trying to follow the 4 Percent Rule with at least $100,000 invested. The rule says that you can likely withdraw about $4,000 a year for every $100,000.

This assumes, however, that you are following a specific portfolio mix that has about 50% in stocks. This is important for your rate of return to at least match that of the market overall.

If your rate of return is higher or lower, or the current economic climate is in a recession or depression, it may be a good idea to make different plans.

The rule also does not account for taxes. If you are withdrawing $4,000 from your IRA, you will need to account for the taxes to be paid on that sum.

Given these potential drawbacks, should you follow the rule?

Is the 4 Percent Rule Good to Follow?

The 4 Percent Rule is at best a general guideline that may or may not be the best guideline for your own personal financial situation. On the one hand, the rule is very conservative. On the other hand, it is formulated for a very precise profile allocation, and it does not even take taxes into account.

Rather than assuming that the 4 Percent Rule is the best rule for you to follow, it is a good idea to speak with a Certified Financial Planner®. A Certified Financial Planner® can help you to get a clear picture of your financial situation, make recommendations for portfolio allocation, and help you come to a clear understanding of what your options are for a retirement withdrawal rate. There is no substitute for having a clear picture of your financial situation and planning accordingly.

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Michael Schultheiss

Michael Schultheiss is a freelance copywriter of long-form content and other marketing communications (B2B and B2C) in the financial services and FinTech niches. In copywriting, he looks for hungry crowds. Other interests include health, fitness, and reading and writing fiction.

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