Why the 4% Withdrawal Rule Is Wrong

If you think it’s because retirees should withdraw less than 4% to make their nest eggs last, that's not quite it. In fact, maybe they could withdraw more than 4%, at least at first.

(Image credit: ©JGI/Tom Grill/Blend Images LLC)

What if I told you one of the most common guidelines people use to plan for retirement is wrong? Further, what if I told you that making the mistake of following it can greatly impact the quality of life you live in retirement and the longevity of your savings?

Well, here goes.

More than 40 years ago, financial adviser William Bengen developed what is known as the “4% withdrawal rule.” This rule of thumb states you can withdraw 4% of your portfolio in the first year of retirement, adjust the amount withdrawn each year for inflation and safely avoid running out of money over three decades. (After further study, he later modified it to the “4.5% rule,” but still rounded it down.)

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A great deal of thought and stress is put into planning and executing an appropriate withdrawal strategy. It’s arguably the most important factor for financial success in retirement. Taking out too much from your savings will lead to a shortage in your later years and potentially put your retirement at risk. On the other hand, spending too little could mean a lower standard of living than you want, or not fulfilling some of your retirement dreams.

Of course, by definition, rules of thumb are never meant to apply in all situations. However, it can be argued the hard, inflexible 4% rule shouldn’t be given much consideration to begin with.

The issue with inflation

The biggest flaw is in its annual inflation adjustment. Outside of health care, most retirees won’t see their expenses dramatically rise. In fact, overall expenses typically decline in retirement. According to the latest data from the Bureau of Labor Statistics, people ages 55 to 64 spend on average $60,076 per year, while people ages 65 and over spend $45,221, which is $14,855 less each year.

That’s why, in all my years as a financial adviser, I’ve seen very few, if any, clients give themselves a pay increase every single year.

The impact of market volatility

Furthermore, it’s important to be mindful of market conditions. For instance, it’s generally not a good idea to increase your withdrawal amount during a market downturn. Instead, you may want to consider a small, temporary cut. Especially, during a deep recession along the lines of 2008. In a best-case-scenario, this simply means making a few sacrifices, such as substituting a trip closer to home for a big vacation overseas. Other times, you may have a big, one-time expense to plan for. This is what I call a dynamic, or flexible, withdrawal rate.

The lack of flexibility

The reality is the 4% rule isn’t dynamic, so it doesn’t accurately reflect real-life spending habits. As in your working years, your income needs throughout retirement will also change. Early in retirement, you’re more likely to be active with travel, new hobbies, working on your home and other activities. So you may want or need more money. Over time, you’ll probably cut back on these big-ticket items for smaller, less expensive ones. Though by then medical expenses may begin to creep up. But, in a period where you have high medical costs, you will likely have reduced expenses in other areas.

One possibility: Dig deeper to start with

If you don’t anticipate your expenses, as with the average retiree, to rise as swiftly as inflation does, you may want to plan on withdrawing more than 4% in the early years of retirement. If you run a Monte Carlo simulation — a tool for assessing the probability of a portfolio’s survival — in your retirement plan, adjust the rate of inflation down and you’ll find that a withdrawal rate of 5% - 5.5% still leads to a high level of success. But Monte Carlos don’t accurately reflect real life. They don’t show the human element of making a smart adjustment to your withdrawals when markets drop.

Is an extra 1% really a big difference? Absolutely. For example, if you calculate that you need $54,000 in income from your personal savings in retirement, at a 4.5% withdrawal you would need to save $1.2 million to retire. But at a starting dynamic withdrawal rate of 5.4%, you would only need $1 million. For someone saving $1,000 per month during their later working years and earning 6%, you’d be able to retire a little more than two years earlier. Or, you could take the stance that you’d work and save the same length of time but have an extra $1,000 per month in cash flow.

If you’re a Nervous Nellie

However, with longer life expectancies and historically low bond yields, some may consider even 4% excessive. If you’re nervous about the risk of outliving your savings, you’re not alone. In a survey by financial firm Allianz, 61% of Baby Boomers said they are more afraid of running out of money before they died than death itself.

Fortunately, there are steps you can take to calm your nerves without making extreme lifestyle changes. One option is to simply build a larger nest egg, which may mean extending your retirement date or saving more during your working years. Or, you may be more comfortable starting with a lower withdrawal rate, provided all your expenses are covered. Then, you can gradually increase your rate as you become more confident in the survivability of your portfolio. With either option, the worst that can happen is you end up leaving a bigger financial legacy.

The bottom line

In any case, it’s safe to assume that you’re not going to put your spending on auto-pilot in retirement. With a little flexibility and planning, you can broaden your income options in your favor.

This information is for educational purposes only and does not constitute investment advice. Please contact your investment adviser regarding your specific needs and situation.


This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Sean McDonnell, CFP®
Financial Adviser, Advance Capital Management

Sean McDonnell, CFP®, is a financial adviser at Advance Capital Management, an independent registered investment adviser based in Southfield, Mich. He works closely with clients to create and implement customized financial plans, as well as provides a wide range of services, including: investment and 401(k) management, retirement planning and tax strategies.