The 4% Rule for Retirement Withdrawals – Is It Still Safe?

The 4% rule for retirement withdrawals is one of the more debated and talked about concepts in the personal finance world.

In this post, I'll tell you where the concept originated and point you to the latest research topic.

Most importantly, I'll tell you whether the rule is still relevant in today's low-interest-rate environment.

The 4% Rule Defined

The 4% withdrawal rule is also called the 4% rule or the safe withdrawal rate (SWR). The rule refers to the amount of money you can “safely” withdraw from your retirement accounts without running out of money.

There are many things to consider when calculating the 4 percent rule.

Here are the top three.

  1. The starting value of your portfolio
  2. An assumed return on the portfolio
  3. A life expectancy factor

Let's say you have a $1,000,000 portfolio of stocks and bonds. The 4% rule means you would take out $40,000 annually for income. The assumption is that your investments would earn a return higher than 4% (on average) to maintain your principal through retirement.

I'll talk more about the problems with this later. For now, these are the basics.

The Origin of the 4% Rule

The rule originated with a 1994 article by William Bengen. The title of the paper was Determining Safe Withdrawal Rates Using Historical Data. Mr. Bengen used historical market data for 30-year rolling periods. He wanted to focus on how the severe market downturns of the 1930s and early 1970s impacted portfolio withdrawals. The study determined that the 4% withdrawal rate was a sustainable withdrawal percentage to maintain the income level over a 30 year period without depleting the portfolio.

A study by three professors from Trinity University in San Antonio, TX, updated the Bengen study in 1998. For the most part, the Trinity Study affirmed Mr. Bergen's previous work. Researchers often call the study the 4% rule.

Both studies assume the percentage that's withdrawn each year adjusts for inflation. Both studies show the strategy offers the best chance for an individual not to outlive their money.

Initially, the assumption was for an investment allocation of 50% in the S & P 500 and 50% in intermediate-term government bonds. He also tests stock allocations of 25%, 50%, 75%, and 100%. As you would expect, the larger stock allocations offer better longevity. The results come from the historical past market returns from 1925 to 1994.

The idea was to include several severe market events (depression, several significant market downturns) to see how/if that impacted the results. The study looked at 30 year rolling periods to come up with the results. The 4% number was what the study indicated would sustain the portfolio throughout a 30-year retirement.

The Trinity study recently got updated. You can read about it in this article by Wade Pfau, one of the premier experts on retirement planning.

The 4% Rule – A Rule of Thumb

It will help if you view the rules of thumb as a starting point in most things. When talking about the success of your retirement, it definitely applies. Too many people rely on the 4% rule as gospel when contemplating retirement.

Earlier, we mentioned the three factors (starting portfolio size, assumed return rate, life expectancy) to consider using the 4% rule. Many other factors can derail the plan. Things like:

  • Higher than expected inflation
  • Lower than anticipated interest rates
  • Lower than expected stock returns
  • Higher than anticipated retirement expenses
  • A catastrophic health event

Let's break down the three mentioned earlier one by one.

Starting Portfolio Value

We looked at how to calculate the income generated from a 4% withdrawal rate from a $1,000,000 starting point. That math is pretty simple. But how do you determine how much income you will need in retirement if you're ten or twenty years away?

First, decide on the calculation method for determining income needs. There are many options. Here are two of the most popular.

The most common uses a percentage of your current income. The rule of thumb here is to plan to provide 70% – 80% of your income. So if you currently make $100,000, you would prepare for a retirement income of $70,000 to $80,000.

Another method is to calculate the income need based on current expenses. Many feel using this method is more accurate. Computing retirement income as 100% of current monthly costs is considered a more conservative way. I tend to be conservative when doing this math. So, I would use this method.

Whatever method you choose, you must calculate the desired income into a starting portfolio value. Once again, there are problems with this method. For now, we'll keep it simple.

Calculation Example

Let's say you need a retirement income of $70,000, and you're going to retire at age 67. You want to plan for a long life expectancy to be even more conservative. We will use age 92. That means your income needs to last for 25 years.

The 4% rule says you would need $1,750,000 to provide that income without eroding your principal. If you have investment accounts (taxable, IRA, 401(k), etc.) totaling $750,000, you need to save another $1,000,000 to make up the difference.

If you're currently age 50, that means over the next seventeen years; you'd need to sock away $35,445 a year, earning 6 percent to make up the shortfall. And this average return in the example is a constant 6% per year. It doesn't account for any market fluctuations.

Do you see the difficulty in the calculation?

Unless you want to leave a considerable legacy, why calculate maintaining your principal value to the end?

The Assumed Rate of Return

The assumed rate of return is where things get tricky. Performances in the study may not reflect the returns in the future.

One major factor is that bond yields have been substantially lower in recent years than in the past. The current ten-year Treasury rate on July 28, 2020, was 0.59%. The rate is unlikely to go back to the levels of the late 1970s and 1980s. Some of you remember those days. Interest rates and inflation were in double digits for much of the decade. That skews the return number considerably.

Back then, people retiring could live off the bonds and fixed income investments like CDs. When you could take out double-digit incomes, it made retirement planning more manageable.

The bigger problem in those years was that inflation was just as high. So, the buying power of the money diminished due to much higher inflation.

Since the financial crisis of 2007- early 2009, interest rates have been near zero. That means replicating the kinds of returns needed; you'd have to have more money invested in stocks. Many people want to reduce the amount in equities at retirement to reduce the risk of their investments. However, to maintain buying power and generate the returns necessary to make their money last, many retirees have more money in stocks than they want.

Dividend yields on the S & P 500 are around2% or so. That's well below the 4 percent SWR. The days of living off the interest are gone and likely not coming back any time soon.

The total return approach is how most retirees are getting the income they want.

Life Expectancy

Planning for how long you will live is one of the more difficult decisions. Plan for a life expectancy that's too long, and you risk living on less than you might want or need. Plan for one that's too short; you risk running out of money. I think it's best to err on the side of caution. It's much better to plan for a longer than expected life than to risk running out of money because you didn't.

So, what's the age to use? Recent studies show that there is close to a 50% chance that one person of a married couple age 65 will live to age 92. To me, that's the starting point. Many use age 95 or even age 100. That may sound crazy, but with advances in health and health care, we live longer than at any time in history. On average, if you're a woman, you will live from five to seven years longer than men.

Remember, the SWR is a rule of thumb. It provides a way to keep your original starting principle value intact. There is plenty of flexibility in the calculation to adjust spending and income along the way.

Get better returns on your money? Great. Take more income that year. Get worse returns? Cut back. Be flexible and willing to make adjustments.

Problems With the 4% Rule

Financial and retirement planning should be about your goals. For some, leaving a substantial legacy is a stated goal. In that case, the 4 percent rule, which preserves and grows your capital in many instances, makes sense. For others, that's not the case.

Here are a few of the variables that can cause the 4 percent rule to fail.

Healthcare Costs

The older we get, the more our healthcare costs will increase.

According to a recent Fidelity study, the average American will spend $280,000 in health care costs. This MarketWatch article, Healthcare will cost $280,000 in retirement – and that doesn't include this huge expense, highlights the study's main points.

According to LongTermCare.Gov, in 2016, a semi-private room's national average price is $225 a day. That's roughly $6,750 monthly or over $82,000 a year. So a one-year stay in a long-term care facility adds another $82,000 to the $280,000 total.

Even cutting the long-term care costs in half, the total healthcare bill rises to $321,000. For a thirty-year retirement, that's an additional almost $11,000 a year expense. And that's just for one person. If married, this potentially doubles.

For a 25 year retirement, the cost increases to between $13,000 – $26,000 annually.

Many retirees will have difficulty coming up with an additional $1,000 to $2,000 or more a month! It will be next to impossible to cover the higher amount.

Required Minimum Distributions (Rmds)

Many people at or nearing retirement have significant amounts in traditional IRAs or employer retirement plans. For most, they have been the best option for socking money away for retirement.

For those with large balances in these accounts, you likely know that the IRS requires you to begin taking that money out at age 72 1/2. Depending on these accounts' size and how long you live, RMDs may require you to withdraw much more than 4 percent. There are ways to minimize the impact of RMDs.

First, determine a projected account value at age 721/2.

When you have that number, consider these two options to minimize the impact of RMDs.

  1. If you're over age 59 1/2, begin withdrawing from these accounts early. Reducing the amounts in the plans at 70 1/2 offers more control over when and how you take income. Plus, you don't pay the additional 10% penalty after age 59 1/2.
  2. Consider converting some of these funds to Roth IRAs. It's not necessary to convert them all at once. You can make partial withdrawals yearly. Keep taxes minimized by converting just enough to keep you from going into a higher tax bracket.

Of course, there are other things to consider with this strategy. If you're taking Social Security, additional income may increase the taxes you pay on your Social Security benefit. You have to look at the total picture when deciding how to take your income.

If this strategy works for you, the result is you will have less money in taxable IRAs when you have to begin withdrawing. You also have more control over how and from what sources you take your income.

Other Sources of Retirement Income

The SWR doesn't consider what other sources of income you might have. These days, many retirees continue to work part-time in retirement.

Depending on your age at retirement, you could have income from Social Security. If you work for a state, local, or federal government, you will have income from your pension. In my area, however, the government is the biggest employer. As such, pensions are a big part of retirees' income. Less than 10 percent of private companies still offer pensions. So, for most, this isn't an issue.

Though there is much hand-wringing over whether Social Security will be around, I'm convinced it will be. As dysfunctional as Congress can be, no one wants to be known as the person who gutted Social Security. If history repeats itself, they will swoop in at the eleventh hour and implement a fix.

To calculate how much income your investments need to provide, subtract all other sources (income from work, Social Security, pensions, real estate)  from your desired income. Divide that amount into your portfolio value to determine your withdrawal rate.

For example, if you want $100,000 in income,  and your combined household income from Social Security and part-time work is $65,000, your investment would need to provide the other $35,000. If your investment accounts total $1,000,00, that's a 3.5% withdrawal rate.

Consider all the variables when using a retirement calculator.

Final Thoughts

Using the 4% rule as a starting point is a good exercise. It's great for getting a ballpark figure of how much money you need to get you through retirement with the income you want. It isn't a be all end all solution for most people.

If you start calculating early and use the calculators and tools available or hire an independent financial advisor, you can put a plan in place to put you on a track to have the kind of retirement income you desire.

If you want to leave a substantial legacy for your family, church, or other charities, accumulating the capital to support the 4% withdrawal and maintain or grow your principal is a good strategy. Even then, though, the variables along the way may require adjustments. Things like inflation, interest rates, market returns, unexpected healthcare expenses, and other unforeseen events often need adjustments.

Why should we expect retirement to be any different than pre-retirement concerning unexpected events? We shouldn't. Be flexible. Understand it's a dynamic process. Use the SWR in a way that fits your situation.

Author: Fred Leamnson

Expertise: Personal finance, Investing


As a financial advisor for almost 30 years, Fred shares his expertise on personal finance, investing, and other relevant topics on Wealth of Geeks and many other financial media. He has been quoted or featured in Money Magazine, MarketWatch, The Good Men Project, Thrive Global, and many other publications.