The 4% Rule Gets a Closer Look

The go-to rule for retirement spending was created 28 years ago. Things have changed since then.

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(Image credit: Getty Images)

The TV show “Friends” had just debuted, and the year’s hottest song was Ace of Base’s “The Sign” when financial adviser William Bengen created the 4% rule, a general guideline for how much to safely withdraw in retirement. But that was in 1994, and it’s fair to ask whether his formula still holds up.

How the 4% Rule Works 

Let’s say you start with a $2.5 million portfolio. In your first year of retirement, you can withdraw 4% of your total balance or $100,000.

That sets your baseline. Each year thereafter, the withdrawal amount increases with the inflation rate. If inflation is 2% in year two, you withdraw $102,000.

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In theory, this formula means that “under a worst-case investment scenario, your savings should still last 30 years,” says Karen Birr, manager of retirement consulting at Thrivent in Minneapolis. In practice, however, the formula may require adjusting because Bengen made several assumptions when he devised the rule that don’t always apply today.


First, he assumed that a retirement portfolio would be split approximately 50/50 between stocks and bonds, basing returns on historical market data from 1926 to 1976. “There are some issues with using historic returns,” says Dan Keady, a certified financial planner and chief financial planning strategist at TIAA in Charlotte, N.C. For one thing, bond interest rates were higher then, whereas Keady says retirees today

could need a higher stock allocation—up to 75%—to generate enough income.

Investing more in stocks in a bear market when the bottom seems nowhere in sight can be tough for retirees to stomach, so another option is to lower the 4% baseline withdrawal rate to “a little over 3%, maybe 3.3%,” says Keady. This means you will need to either accept less income or have more saved for retirement. To generate the same amount of income at 3%, your portfolio must be 33% larger.


Bengen also assumed that retirement savings should last 30 years. Over time, however, life expectancies have risen, and today, savings may need to last 35, even 40 years. This too might imply lowering the 4% rate except some financial advisers say that risks too much austerity, especially if markets bounce back. “We commonly see people are so cautious with their spending, they end up with more money three to five years after retiring,” says Sri Reddy, senior vice president for retirement and income at Principal Financial Group in Des Moines, Iowa.

In fact, Bengen himself suggested raising the target rate to 4.5% or even 5% when he saw that many retirees were dying before spending down their savings.

“Having a surplus at the end of life is not a bad thing,” says Birr. “Just make sure it’s something you want.”

If you’re worried about outliving your savings, Keady suggests transferring part of your portfolio to an annuity for guaranteed lifelong income. An annuity combined with Social Security should deliver enough income to cover essential needs, with the 4% rule applying to your investment portfolio for discretionary spending, like vacations and hobbies. In a bad investing year, discretionary spending can be cut back without affecting the essentials.

Inflation. When Bengen created the 4% rule, inflation averaged a modest 2% to 3% compared with 8.6% in May. For the newly retired, withdrawing more at the start to keep pace with inflation, particularly when the market is down, can throw retirement planning off track. Let’s say we have two years of 7% inflation, Keady says. 

Someone who started withdrawing $100,000 a year would be taking out $114,490 in year three. That’s hard to sustain as you’ll keep building off those higher-than-expected withdrawal rates.

One solution is to review your portfolio performance and inflation each year, adjusting the withdrawal rate to match your target. If inflation pushes up the baseline withdrawal rate to 6% a year, scale it back.

If a bull market sends your portfolio balance soaring, you may be able to take out less than 3% or 4% with no change in lifestyle. Once you turn 72, required minimum distributions may force you to withdraw more than you prefer. “The first-year RMD percentage starts at 3.65% and increases as you get older,” says Birr.


Adjusting the withdrawal rate annually also addresses another Bengen assumption: that retirement spending rises linearly when, in fact, it fluctuates.

Retirees tend to spend more early on. “As they get older, spending usually slows down, before possibly picking up again for late-life health care costs,” Reddy says. He prefers that clients spend more in the beginning and adjust their budget later if it appears they might run short. Remember, the 4% rule is only an estimate because everyone’s situation is different, Birr says. “Life events will happen, and you need to be flexible.”

David Rodeck
Contributing Writer, Kiplinger's Retirement Report