What Is the 4% Rule in Retirement? Myth vs. Fact
Retirement means relaxing, traveling or taking up new activities. No more stressful commutes or long meetings. Instead, you can do all the things you couldn’t do when you were working full time. If you’ve researched ways to prepare for this financially, you may have come across the 4% rule for retirement.
Retirement can feel like a dream. But the cold, hard truth is retirement means losing your salary and shifting to Social Security and/or pensions to pay bills. Ideally, you’ll have set some money aside for retirement, whether it’s in the form of a 401(k), IRA or savings. But that money has to last for the remainder of your life. The question then becomes how much to take out.
“The ‘4% rule,’ a guideline suggesting retirees withdraw 4% of their retirement savings in the first year and then adjust for inflation in subsequent years, has been a staple of retirement planning advice for decades,” said Satayan Mahajan, CEO at Datalign Advisory. “However, it’s essential to recognize that there is no ‘one size fits all’ approach to retirement withdrawals.”
What Is the 4% Rule for Retirement?
The concept of the 4% rule for retirement started in 1994. That’s when a former financial advisor named William Bergen tried to answer a question he regularly got from clients. How do you use your retirement savings while also ensuring you have enough to last? He decided to crunch the numbers himself.
The results were published in the Journal of Financial Planning, revealing his take on what he learned. His theory at the time was that if you spend 4.2% the first year of retirement, then adjust that amount each year for inflation, you’ll have a 90% chance of your savings lasting 30 years.
But as Anthony DeLuca, CFP, CDFA and expert contributor at Annuity.org, points out, with inflation, the dialogue has shifted to a 6% rule. That ups the amount you withdraw each year. But whether it’s 4% or 6%, DeLuca has thoughts about retirement spending rules.
“Frankly, my thoughts on the 6% rule are the same as the 4% rule,” DeLuca said. “It is too rigid of a concept for any one person to follow. There are so many variables that fit into one’s retirement plan that the use of any general rule without a financial plan is guesswork.”
The economy has shifted considerably since Bergen’s number crunching in the 90s. But how much should you spend each year in retirement? Let’s debunk a few retirement spending myths to help you create your budget.
3 Retirement Spending Myths
The below myths show that while retirement spending can get complicated, you can find the right approach.
Myth #1: Conservative Spending Is Always Best
At the start of retirement, it can feel critical to stay on the conservative side. It’s better to die with money in the bank than run out of money a few years in.
But DeLuca said the problem with the 4% rule for retirement is it assumes you have a portfolio that’s half equity and half income. Upping that amount to 6% means you’ll need to take more risk with your portfolio to compensate for the extra amount.
“The goal in retirement is to enjoy earned assets, protect principal and find appreciation that can effectively outpace inflation without enduring too much risk,” DeLuca said. “I would rely on working with a CFP and building a financial plan that considers your needs, your risk tolerances and your goals.”
Myth #2: Your Savings Won’t Grow in Retirement
Unless your retirement money is in a low-interest bank account, you’ll continue to earn interest on the money throughout retirement. In fact, Vanguard CFP Ryan Wibbens said some retirees are too frugal in retirement. They aren’t making the most of the money they worked so hard to earn over the years.
“A withdrawal strategy should accomplish two often-competing goals,” Wibbens advises. “Having enough money to support your desired lifestyle and ensuring there’s enough left for the future, including any money you plan to leave to heirs.”
Myth #3: All Retirees Face the Same Financial Challenges
The biggest issue with following the 4% rule is it lacks flexibility. Chris Urban, CFP, RICP and founder at Discovery Wealth Planning said retirees vary in their day-to-day activities. Some have more expensive medical bills or spend their golden years traveling. These factors can shift the amount of money you should take out each year.
“In my opinion, it is much better to have a dynamic spending approach for retirement,” he said. “One that can change over time with a retiree based on changing investment portfolio returns, longevity, legacy and life goals.”
Once you’ve wrapped your head around the 4% rule for retirement, look at your overall financial picture and craft a plan that’s best for you. A skilled financial advisor can help with that. Or, set a budget you can revisit and tweak as you learn more about your post-retirement lifestyle.
Stephanie Faris is a professional finance writer with more than a decade of experience. Her work has been featured on a variety of top finance sites, including Money Under 30, GoBankingRates, Retirable, Sapling and Sifter.
