Strategizing for a successful retirement withdrawal plan can often feel like a nerve-wracking gamble with high stakes. The daunting task of ensuring that your savings will sustain you throughout your lifetime requires meticulous planning. Over the years, numerous economists have proposed methods that eliminate the guesswork from withdrawal planning, and one of the most well-known strategies is the 4% rule. Despite its historical relevance, it is crucial to understand the inner workings of the 4% rule, assess its relevance in today's ever-changing economy, and determine whether it aligns with your unique circumstances and retirement goals.

What is the 4 Percent Rule?

The 4% rule is a retirement withdrawal strategy. It states that you can withdraw 4% of your savings during your first year of retirement, and then adjust that amount based on inflation for subsequent years. The idea is that using this formula your retirement savings should last you at least 30 years, giving you enough money for the rest of your life.

The rule was modeled by financial advisor William Bengen in 1994, in a paper called “Determining Withdrawal Rates Using Historical Data.” Bengen calculated that the 4% rule would allow most people’s retirement portfolios to last 30 years or more—in some cases, he found the rule stretched the savings to last 50 years.

How the 4% Rule Works

One reason the 4% rule has become so popular as a withdrawal strategy: it’s easy to calculate and follow. Let’s say that you have added up all your accounts and know you have $1 million saved for retirement. During your first year of retirement, you’d withdraw $40,000. If the rate of inflation rose by 2% in the next year, you’d withdraw $40,800 ($40,000 x 1.02). You’d calculate the opposite way as well, during periods of deflation. So if the cost-of-living went down by 2%, you’d spend $39,200 that year ($40,000 x 0.98). You would adjust the amount in subsequent years based on the previous year’s withdrawal amount plus the change in inflation.

Important Insights into the 4 Percent Rule:

The 4% rule is popular, has been around a long time, and works for some people, but there are some caveats to note before you make this the only guide for your retirement withdrawal strategy.

1. It’s only relevant if you have a specific portfolio: Bengen’s calculation was based on portfolios that were composed of 50% stocks and 50% bonds, with tax-deferred accounts like traditional IRAs or 401(k) accounts. With these accounts, you’ll pay taxes on your withdrawals. If you have a Roth account, however, your withdrawals won’t be taxed, and the withdrawal calculation could be entirely different.
2. It’s strict: The strategy adjusts your spending based on inflation, rather than your portfolio’s performance. In addition, it doesn’t take into consideration the fact that you might spend more in some years and less in others.
3. The data is outdated: The data used to calculate the 4% rule is from the 1990’s, but the return rate today is often lower than it was then, so a 4% withdrawal amount might in fact be too liberal.
4. Taxes aren’t included: The formula assumes that you will pay taxes (and investment fees) with your yearly allowance—so if your taxes are $7,000, and you have $40,000 using the 4% rule, you will only have $33,000 in usable income.

How to Use the 4 Percent Rule as a Guideline

Here are the steps necessary to apply the 4% rule to your retirement savings and see how the numbers pan out.

Determine how long you will plan on spending

While the 4% rule was originally used as a guide to guarantee your retirement savings would last 30 years, you might need your money to last you longer. Calculate when you wish to retire, your state of health, and factor in the average lifespan for people like you. Give yourself a few years of wiggle room, too.

Review the way your portfolio is invested

As mentioned, the 4% rule assumes about a 50/50 split between stocks and bonds. Consider how your portfolio is distributed and if this makes the most sense for you, given your risk-tolerance, age, and how much you already have saved. A financial advisor might not advise that a stock/bond split is the best option for you—everyone’s situation is different. Figure out if your money will last based on your income and spending habits

Given how much you have saved now and how much you plan to have during retirement, will a 4% withdrawal rate be enough? It’s possible that’s too conservative or too liberal, depending on your age, health, and spending habits.

Making changes to your spending as conditions change

To stick to the 4% rule, you may need to adjust your spending significantly. This might mean moving to a place that has a lower cost-of-living, or cutting out costly activities, like travel and eating out. If you aren’t willing to do this, the rule might not be the one for you.

Frequently Asked Questions

Does the 4% Rule Still Work in 2024?

Bengen himself has stated that he believes the rule is now outdated, and believes that if you’re able to add a third asset to your portfolio—small-cap stocks—you could withdraw as high as 4.7 or 4.8%. That said, other economists believe that given high inflation, 4% is too liberal and a 3% withdrawal rate would better suit today’s economy, given high inflation. Ultimately, the withdrawal strategy you choose should be determined by your savings, spending habits, age, health, and ideally, with the guidance of a financial advisor.

Does the 4% Rule Work for Early Retirement?

Some of those who have joined the FIRE (“Financial Independence Retire Early”) movement have latched on to the 4% rule as a guide, but remember that the rule originally only assumes 30 years of withdrawals—for some people, that doesn’t exactly equate to a truly early retirement. FIRE investors often seek ways to retire for 40 or even 50 years. Often, there are multiple tweaks you will need to make to retire early, such as: diversifying your portfolio to include international assets, implementing a dynamic spending strategy, and adjusting your spending.

What are some alternatives to the 4% rule?

There are many alternatives to the 4% rule. You could, for instance, draw from dividend-paying stocks and a single-premium immediate annuity. You could also simply do the math on your savings, current age, and life expectancy, and divide accordingly for the number of years you anticipate living (and adjust your lifestyle to meet that withdrawal amount). Finally, many economists recommend simply adjusting your spending based on how the market and your returns are performing—this is called dynamic spending. You spend more when the markets do well, and less when they don’t.