Making Your Money Last

The 4% Rule: How a Good Principle Leads People Astray

Investors often misuse the 4% rule, steering them away from solutions that could more effectively make their money last in retirement.

When I first started in this career, people commonly asked questions like, “Markets average around 10% annually, so I shouldn’t I be able to withdraw that much from my investments in retirement?”

I met numerous retirees who had been way too aggressive in both their portfolio and distribution plan, with many now facing huge shortfalls. Fortunately, since the 4% rule became mainstream, most investors now keep their asset mix and withdrawals within a safer range, making such outcomes far less common.

This rule changed the game, and helped prolong portfolio longevity for countless retirees. Despite the rule’s success, however, its popularity has created a whole new set of problems in how it is commonly applied.

Origins of the 4% Rule

The rule was introduced by William Bengen in a 1994 article in the Journal of Financial Planning. It suggests that if you make annual withdrawals of 4% or less of your portfolio’s starting balance, and you follow a moderate stock/bond mix, you can expect your money to last for at least 30 years. Better yet, you can increase each subsequent year’s withdrawal to account for inflation. This idea was tested across all market conditions since 1926, and found to hold true in the historical tests.

Although the rule has come under question by those concerned with today’s conditions, it’s worth noting that the historical data supporting Bengen’s conclusion contains several severe market scenarios, including the 1930s. The fact that it held up through the Great Depression should provide some degree of comfort.

Financial writer Michael Kitces (host of the Nerd’s Eye View blog) tested the scenario even further, using data going all the way back the 1870s. The rule not only remained true, but he found that in over two-thirds of cases, the portfolio had more than doubled at the end of 30 years.

Past performance is never any guarantee of future results, but if you’re looking for a guideline that helps you spend not too much and not too little, the 4% rule appears as useful as ever.

Unexpected Problems Caused by the Rule

The problem is not that the rule is somehow broken. On the contrary, the issue we’ve found is that the rule is so widely followed that it often has an adverse effect on people’s behavior.

For example, I met a 64-year-old transitioning into retirement who had just elected to commence her Social Security benefits, despite her wonderful health and family longevity. When asked why, she explained the need to keep her income smooth to ensure her withdrawal rate didn’t exceed 4%.

Had she come to me sooner, she could have at least considered deferring her benefits to age 70, which could have resulted in far more income over her lifetime. In many cases, maximizing Social Security benefits can be the strongest form of insurance against longevity risk.

This person’s line of thinking is unfortunately all too common, and can cause a great deal of harm. When people attempt to reconcile their planning with the 4% rule, they tend to plot a straight-ahead course that is far too simple. For instance, they might turn on all possible income sources from day one, or take withdrawals proportionally from all accounts regardless of opportunities to reduce lifetime tax bills.

Unfortunately, such planning can fall short of the challenge presented by today’s retirement reality. Interest rates are low, market valuations are high, and modern medicine continues relentlessly extending our lifespans. Proper planning has never been more critical.

The best solutions to this problem rarely resemble a straight line. A robust retirement income plan is much more dynamic, built upon a series of key decisions that can cumulatively help tilt the odds in your favor.

Proper Retirement Planning

To maximize the likelihood of making their money last, prospective retirees should evaluate questions like:

  • When should Social Security benefits begin?
  • How much should I withdraw from each account, and how will that change over time?
  • Which pension option should I elect, and when should benefits begin?
  • Are there any opportunities to reduce my lifetime tax bill, such as Roth IRA conversions or realizing capital gains during a low-income year?

Once the answers have been crafted into a finely tuned distribution plan, the portfolio should be calibrated around it, rather than vice versa. Anticipated withdrawals can be invested more conservatively, while longer-term assets can be positioned into higher-growth investments. In addition, stocks should often be emphasized in taxable accounts where they receive favorable tax treatment, with bonds correspondingly increased in IRAs. This level of planning and customization can potentially lead to superior investment results.

In modern retirement planning, it can often be advisable to have an initial withdrawal rate well over 4%. For instance, many people make larger distributions in the early years of retirement before Social Security benefits kick in. There also might be unusually high distributions if an account or position is purposefully liquidated, whether for tax reasons or to cover a large expense. The portfolio can still be sustainable, as long as the withdrawal rate drops later in retirement as other income sources commence.

This type of planning may be hard to reconcile with the 4% rule, but it can be worth the effort if it significantly strengthens your retirement.

The 4% rule is a useful guideline, not a dictum. Be careful not to let it stand in the way of making proper decisions that could help prolong your portfolio’s life.

About the Author

Michael Yoder, CFP®, CRPS®

Principal, Yoder Wealth Management

Michael Yoder, CFP®, CRPS®, writes about issues affecting retirees and those transitioning into retirement. He is Principal at Yoder Wealth Management (, a Registered Investment Advisor. 2033 N. Main St., Suite 1060, Walnut Creek, CA 94596. 925-691-5600.

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