In today's ever-changing economic environment, it seems as though traditional retirement withdrawal strategies may no longer apply. For decades, most retirees have abided by what's known as the 4% rule—considered a safe and reliable way to ensure income throughout your golden years—but this principle may be a thing of the past.
What is the 4% rule?
The 4% rule is a retirement withdrawal strategy that states if retirees withdraw no more than 4% of their retirement assets per year, they could reasonably expect their funds to last 30 years. Financial advisor William Bergen
However, nearly 30 years after his original research, Bergen has revisited the 4% rule, saying in a 2021 interview
Does the 4% rule still apply?
As observed over the past two years, the stock market, inflation and cost of living can shift dramatically from day to day—so, sticking to a hard-and-fast rule for retirement withdrawals may be a thing of the past.
Several factors can affect the balance of a person's retirement account, and anticipating how much you'll need to live comfortably each year is an imperfect art. Ultimately, it may not always make sense in practice to stick to an inflexible rule.
Here are a few reasons why the 4% rule might be past its prime.
1. People are generally living longer
Americans today live much longer than previous generations on average. Today, a 65-year-old man has a
Someone who lives well into their 90s could have a retirement that is far longer than 30 years—and the longer the retirement, the longer the money needs to last. If you make 4% inflation-adjusted withdrawals every year and you have a 35-year retirement, it's possible that your savings may run out.
2. Investment risk varies from person to person
Every person has a different
In 1998, three finance professors from Trinity University published research that explored what a safe withdrawal rate was for different types of portfolios across 15-, 20- and 25- and 30-year payout periods. The
The authors explain that a portfolio of 100% stocks with a 4% annual withdrawal rate would last whether someone had a 15-year retirement or a 30-year retirement. A 100% bond portfolio had a lower likelihood of sustaining withdrawals over decades, especially if a retiree withdrew more than 4%.
The Trinity study confirmed Bergen's original research that a 4% withdrawal rate would generally last a minimum of 30 years in retirement, but it also shows some of the different dynamics that can affect retirement savings. Your allocation influences the flexibility you have to withdraw different percentages from your retirement savings in a given year.
3. Inflation can reduce your spending power
Inflation continues climbing to mind-boggling heights each month, drawing excess funds for everyday necessities such as food, gas and utilities. Our
4. Sequence-of-returns risk may impact investment gains
The stock market fluctuates every day. Some years, the market is up. Particularly during recessions, the market tends to go down. Interest rates in the bond market also fluctuate, which means that you may earn higher or lower yields on your investments depending on the economic climate. Because of this volatility, retirees should pay attention to what's known as the sequence-of-returns risk, otherwise called the sequence risk.
Sequence risk involves watching out for the best times to take cash from your portfolio. It's generally a good practice to avoid withdrawing money in a bear market and wait for a bull market—this is when you can earn a higher yield, optimizing your overall return.
5. Taxes can affect your net retirement income
Depending on the type of retirement accounts you hold, you may have to pay
- If your money is held in a tax-deferred account like traditional IRA or 401(k), you'll have to pay taxes on any withdrawals at your current income tax rate.1
- If your retirement income is held in a Roth IRA, you can make tax-free withdrawals since you initially contributed after-tax dollars to this account. However, earnings will be taxable.2
- If you have a substantial portion of your retirement savings in a taxable brokerage account, you could pay anywhere from
0% to 20% in taxeson any gains, depending on your taxable income and how long you've owned the investment.
Additionally, if you've decided to continue working in retirement or you have multiple sources of income—like a pension, Social Security payments or assets like investment properties—then be mindful of whether these assets could push you into a higher tax bracket. A higher income tax bracket means retirement withdrawals will be taxed at a higher rate.
In this case, it may not be worthwhile to withdraw 4% from your retirement accounts each year. Further, if you can rely on your other assets for income and delay taxes on your retirement withdrawals, you'll give them more time to increase in value.
An alternative to the 4% rule
Sticking to a set percentage for retirement withdrawals sounds good on paper, but it's not always the most effective strategy.
Instead, consider dividing retirement income into buckets. A retiree might split their funds between monthly income for essential expenses and investments to build short- and long-term income.
Here's what that could look like.
Guaranteed monthly income
To ensure you have cash month to month, start by reviewing your sources of guaranteed income, like Social Security payments or rental income. You also should try establishing additional guaranteed income sources to fill any gaps. Look into either a
Additionally, consider setting aside three or five years' worth of expenses in a high-yield savings account to weather market storms. That way, you know you're set for at least that length of time. Keep in mind that this money isn't really guaranteed income (especially when there's high inflation). Rather, it's there to help you cover discretionary expenses beyond your everyday financial obligations so you can maintain a certain quality of life in retirement.
Along with savings and annuities, dividend-paying stocks also might be a good source of guaranteed income, as they allow you to live off dividend earnings without having to sell any stocks. This can be an effective approach when the market is underperforming, minimizing sequence-of-returns risk.
Short- and long-term income
Pay close attention to your asset allocation in retirement and decide what level of risk you're comfortable with. A more conservative portfolio may protect more of your retirement savings, but it could lead to lower returns. A more aggressive allocation may maximize your income, but it risks jeopardizing your retirement savings. Decide which approach is best for you to maximize your chances of a comfortable retirement when you're ready to withdraw.
The bottom line
The 4% rule provides a valuable framework for retirees to plan their retirement withdrawals, but it doesn't account for every variable. Therefore, you should be flexible about your withdrawal rate. A 4% annual withdrawal may not be the right approach in every case. In some years, a safe withdrawal rate may actually be 3% or 6%, depending on what's happening in the market, your current expenses and whether you have other assets you can lean on for income.
As you create a retirement withdrawal strategy for your unique needs, consider talking to a