ByJustin Pritchard, CFP®
How can you get the retirement you want while avoiding unpleasant surprises? Making a plan and checking your progress can improve your chances. But you have to make some assumptions about the future and hope you’re guesses are good enough.
Rules of thumb and “back of the napkin” checkups can help you understand your progress toward retirement. But those are only rough estimates. As you approach retirement—when it’s within 20 years or so—the need for more precise calculations increases.
The so-called 4% Rule is one of the most popular rules of thumb for retirement planning. Some of most important things to know about it include:
- It’s more of a research finding than a “rule.”
- You probably won’t follow the rule exactly, but it’s helpful to know how it works.
- In recent years, critics have argued that 4% is too high, and a slightly lower number might be prudent, but nobody can predict the future.
- Some people argue that 4% is too low.
Continue reading below, or watch and listen to an explanation by video:
The 4% Rule for Retirement Explained
The 4% Rule helps you figure out two crucial pieces of your retirement plan:
- Saving need: If you’re still in your earning and saving years, you can figure out how much you need to save to retire comfortably.
- Potential retirement income: If you’re getting ready to retire, the 4% Rule helps you estimate how much you can “safely” spend from your savings each year (and safely is in quotes because there are no guarantees in life).
As a result, the Rule is useful for both retirees and pre-retirees.
The basics of the 4% Rule:
- You take annual income out of your retirement savings starting with 4% of your retirement savings.
- Income that rises each year with inflation.
- The assumption is that you’re planning for 30 years of retirement.
- That withdrawal rate “should” prevent you from running out of money.
Ultimately, it is possible to run out of money, even with a so-called safe withdrawal rate.
But let’s be realistic: It’s not a rigid “rule” that always works, and I don’t know of anybody who follows a strict 4% withdrawal rate. Instead, it’s a helpful guideline for estimates.
Examples: The number 100 is easy to work with. Assume the following:
- You have $100,000 saved at retirement.
- You take $4,000 per year of income for each $100,000 you have (that’s 4% of $100,000).
- If you have $500,000 saved for retirement, that’s $20,000 of annual income from your investments.
- If you have $1 million, that’s $40,000 per year.
That may not sound like much, but this might make more sense when we look closer. Plus, you may appreciate hearing that Bengen revised the rule to say that you can potentially withdraw 4.5% in the worst-case scenarios he tested. But the term “4.5% rule” hasn’t really caught on.
2 Quick Calculators
Or, use this free spreadsheet template in Google Sheets to see how much money you might withdraw each year in retirement using the 4% rule.
- Tip: For a more robust calculator, try the tool at the bottom of this page.
Increasing Income
Perhaps most importantly, the 4% Rule is designed to provide an increasing income during retirement. In other words, it’s an income that adjusts—at least somewhat—with inflation. So:
- Assume you start with $40,000 of income in the first year.
- The following year, you should be able to withdraw more—$40,800 if we assume 2% inflation that year.
- Each year, withdrawals increase with inflation.
Remember that this amount is just what you spend from your investments. If you receive Social Security benefits, pension income, or other sources of income, those payments can supplement your 4% withdrawal amount.
Does the 4% Rule Make Sense?
So, does it work? It depends. The research originally came out in 1994 based on the work of William Bengen, and it’s been fairly well-established since then. But there’s still debate about the perfect number and the perfect strategy.
Potential drawbacks: People criticize the Rule with a variety of arguments, but it’s a decent starting point to understand if you’re on track.
- Some say that you should withdraw less than 4% or you’ll run out of money—read more on updated withdrawal rates
- Some say you can withdraw more, and 4% is too conservative (requiring you to work longer than necessary or make sacrifices during your saving years).
Ultimately, the outcome depends on several factors, like:
- How you invest: Do you invest in an aggressive or conservative mix of investments?
- How much “certainty” and comfort you want: There is no certainty in this life, but a lower withdrawal rate is safer than a high one.
- How willing are you to adjust your spending?Can you be flexible, reducing spending when markets crash?
- When you retire: How do markets perform? Poor returns or market crashes shortly after you retire can create a “sequence of returns” problem.
- And more
In reality, withdrawals are typically uneven. You might spend heavily in early years (while waiting for Social Security to begin, for example). Then, withdrawals are lower until a need arises. Sticking to any particular rate is a challenge.
You might get away with taking more when the markets work in your favor. In the image above, you see how likely you are to run out of money with various withdrawal rates. If you find 4% (on the left), you see that it was successful—you didn’t run out of money in a 30-year retirement—roughly 85% of the time. But as you try to withdraw more, it’s only successful if you increase your risk (holding higher levels of stock), and only if that risk pays off, which not guaranteed.
A lower withdrawal rate also works. But to provide enough income for yourself, you need to save significantly more.
So, What Should You Do?
A rule of thumb can answer some basic questions and get you in the ballpark. But it’s insufficient for real financial planning. If you want to lean heavily on the 4% Rule, it’s critical to understand the pros and cons—and to be flexible. If you rely on a flat 4% through good times and bad, things might or might not work out. But you take a risk if you stick to a rigid approach.
Use the 4% Rule to double-check any other planning you’ve done.
- If your plan requires you to withdraw more than 4%, do you have a reason for doing so, and have you evaluated the risks?
- If your plan uses less than 4%, are you spending less than you could, and are you doing that intentionally?
There’s no right or wrong answer, and you ultimately get to choose how much you’ll spend. It’s your life to live, and you undoubtedly have your reasons for making any decision. For example, if you’re spending significantly less than 4%, maybe the goal is to leave assets to your heirs, and that’s great. The most important thing is to verify that you’re spending with a plan.
Does the 4% Rule Work for Early Retirement?
A 4% withdrawal rate can potentially work for early retirement, but lower withdrawal rates are safest. That said, some retirees successfully withdraw more than 4% while spending down assets and waiting for Social Security to begin. That strategy is known as a Social Security bridge, and it has several benefits.
Research shows that in many cases, you might not come close to depleting your savings over a 30-year period at a 4% withdrawal rate. Your assets can still grow, possibly leaving you with more money than you started with or supporting longer retirement timeframes. Put another way, you could die with a bigger account balance than you bring into retirement.
So, if you retire early and want to plan for more than 30 years of income, it may be feasible. But to improve your chances of success, it’s best to be open to change, and it’s critical to be proactive about managing risk. For example, if your withdrawal rate gets too high, or if markets fall and inflation is high, it would be wise to take action. That might mean reducing withdrawals, skipping inflation adjustments, or taking other steps to minimize the damage to your nest egg.
Again, I’m not sure anybody follows a rigid 4% rule. As with all rules of thumb for retirement, it’s probably not the best way to manage retirement income and plan for an important goal. Instead, it’s crucial to monitor your plan and take action when needed. The longer you plan to spend in retirement, the more risk you take (but the reward is also significant).
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