The “4% rule” is an oft cited, but simplified, rule of thumb for how much retirees should withdraw from their retirement savings each year to ensure they last.
You’ve worked hard and saved all your adult life, and now you’re thinking about retirement. That’s great! But it can also be scary. You’ve got savings, but do you have a strategy for how you’re going to live off your savings?
When you decide to finally start tapping into those retirement funds, you may have a lot of questions. Exactly how much should I be taking out? How long will my savings last? What if I have unexpected medical expenses? Can I afford to splurge now and then? These are all valid questions, and those of us without a dedicated financial professional must navigate these questions on our own.
The 4% rule was developed in 1994 by the financial advisor William Bengen¹ to provide a conservative plan to make sure retirement savings last. The calculation works no matter how much you start with, and it can provide valuable insight into what your retirement could look like, whether it’s far in the future or just around the corner.
It’s intended to make sure you have a safe retirement withdrawal rate and don’t outlive your savings in your final years. By pulling out only 4% of your total funds and allowing the rest of your investments to continue growing, you can budget a safe withdrawal rate for 30 years or more.
Start by adding up all your investments, retirement accounts, and residual income. Calculate 4% of that total, and that’s your budget for your first year of retirement. After each year, you adjust for inflation. It may sound complicated but consider the work that would go into planning out your budget for the next five years, let alone a 30-year budget. In comparison, the 4% rule is simple enough for anyone to follow.
If you have $1 million in total retirement savings, you will have a budget of $40,000 in your first year of retirement. The next year, you would multiply that $40,000 by the rate of inflation. Let’s say that’s 2.3%. The equation is: ($40,000 x 1.023). In year two of retirement, your budget would be $40,9202². You continue to repeat this for each year of retirement.
No two retirement plans are exactly alike, but when you make a financial framework like the 4% rule, you want it to apply to as many people as possible. That means the creator had to average out quite a lot. It’s important to understand the model used so you can apply it to your specific circumstances. The 4% rule is based on some important assumptions:
You’ll live 30 years past your retirement date.
The 4% withdrawal rule was designed for the classic retirement age of 62 to 65 years with the idea that you’ll potentially need retirement savings into your 90s. Today, retirements take all shapes and forms. Some look to keep working and stay busy into their 70s. Many aim to retire early. And health conditions and medical advances may change the outlook for how long you’ll need those savings.
You have a specific investment portfolio.
The 4% rule was based on a portfolio of 50% stocks and 50% bonds. Most financial planners today will suggest that you diversify your portfolio more than this. It’s likely that your actual retirement savings will differ, and they may include cash, precious metals, investment properties, and more. These all have different growth potential that can render the 4% rule inaccurate.
It’s based on historical market data.
The 4% rule relies on what the market has done and, well, that’s the past. It’s impossible to predict exactly how the market will react to the many challenges the future brings.
It’s perhaps overly cautious.
The 4% rule is meant to be a very conservative approach based on calculations that include some of the worst market downturns in history. For some, this level of caution may not be warranted. For others who want to leave some of their wealth to their family, a conservative approach makes sense.
You may be wondering how you include your future Social Security income in this equation, and the simple answer is, you don’t. It wasn’t designed to take that into account. Think of Social Security as added “security” to your retirement budget.
Financial planners will give you different answers. Ultimately, it’s a guide and not a hard-and-fast rule. Your particular situation is different from everyone else’s, and whether the 4% rule will work for you depends on a lot of factors. Your first step is to consult with a knowledgeable financial professional, who can help you quantify all your various savings and investments and come up with a strategy to make sure you’re comfortable.
Related: What is an annuity?
Financial professionals debate whether the 4% rule is the correct way to approach retirement. There are just as many detractors as there are proponents.
Ultimately, there is no one right answer for everyone. The key is to plan for your retirement. Not a generic one. That includes taking into account your desires, your family’s needs, and even things that might disrupt or change your plans, like medical costs or welcoming new grandchildren.
While it’s not guaranteed, multiple studies of the 4% rule show that there is near certainty that your retirement savings will last for at least 30 years. Of course, this is based on what the stock market has done and not necessarily on what it will do. You may also live longer than 30 years after your retirement.
If you have been aggressive in saving for retirement, you may be able to live comfortably on 4% of your savings. For many, though, this amount will be considerably lower than what they are accustomed to. You might have to readjust your budget and change your lifestyle significantly to stick to the 4% withdrawal rule. Some people are uncomfortable with that change.
Without a dedicated financial professional to help you with all your savings and spending, planning out the finances of your entire retirement can be a difficult task. The 4% rule is an easy guideline that is simple for most people to adhere to.
Since the 4% rule relies on stocks and bonds, it is subject to the market. While this is generally a good thing, the wrong turn at the wrong time in your twilight years could have a drastic effect on your savings. That’s why most financial professionals advise diversifying your portfolio, especially as you get older.
That will depend on your lifestyle, your retirement goals, and even where you live. A single retiree who wants to spend his golden years tending the family farm in rural Iowa will have vastly different needs than a couple from Boston who like to winter in Florida. However, it is unfortunately true that many have not saved enough to live comfortably in retirement.
50% of retirees are at risk of having too little retirement savings to maintain their lifestyle.³
If you are among the half of Americans with concerns about your financial future, there are steps you can take now to help, no matter how close to retirement you are. The trick is to act quickly. The longer you put it off, the harder it can be to change. Our agents can give you a free, no-hassle assessment of your retirement outlook and suggest a path forward.
Life insurance helps protect your family and their future. There are also policies that can grow your wealth at the same time. You can use the cash value of your life insurance policy as a safety net or as supplemental income in retirement if your life insurance needs change⁴.
Annuities can help you address the risk of outliving your retirement savings. They cover a wide range of products that can help you grow your policy value and return a steady income, now or in the future.
Planning for your retirement is one of the most important things you can do. Get started today with guidance and a helping hand from one of our knowledgeable agents.
1William Bengen Wikipedia Page
2For illustration purposes only.
3Center for Retirement Research. “National Retirement Risk Index” Boston College, 2021.
4Accessing the policy’s cash value will reduce the available cash surrender value and death benefit.
5All guarantees are backed by the claims-paying ability of the issuer.