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What is the 4% Rule of Retirement?

Published April 16, 2021

4 minute read

Devon Taylor

By Devon Taylor

Retirement can be a tricky topic. It’s full of many government rules, tax regulations, and theories on the best ways to save and enjoy your golden years. If you Google the term “retirement rules,” you’ll be inundated with advice — both good and bad. Remember that there is a multi-billion-dollar industry built around helping people plan and prepare for a secure retirement. Not all of the previously accepted retirement “rules” have stood the test of time. On the other hand, some of them remain sound advice, even in our modern financial landscape. One of the more reputable rules is what’s known as the 4% Rule (or Four Percent Rule). It states that retirees can withdraw 4% from their portfolio each year and still live comfortably for the duration of their retirement. In this article, we take a deep dive into the 4% rule.

How The 4% Rule Developed

The 4% rule was created in 1994 by American financial advisor William Bengen. He exhaustively scrutinized the historical returns of stocks and bonds over a 50-year period from 1926 to 1976. The 4% rule is also sometimes known as the Bengen Rule, after its creator. You may also hear it called the SAFEMAX rate.

Before Bengen’s study in 1994, financial experts generally agreed that retirees could take 5% from their portfolio each year without exhausting their funds. However, Bengen was skeptical of whether that was truly sustainable. He studied historical returns, focusing on severe market downturns in the 1930s and 1970s. He determined that no historical case existed in which a 4% annual withdrawal rate exhausted a retirement portfolio in less than 33 years.

Bengen published the results of his study and promoted them widely. The 4% rule quickly became adopted across the broader financial planning and retirement industry. Today, the 4% rule helps financial planners and retirees set a portfolio withdrawal rate that will not deplete their hard-earned savings after they stop working.

Other Factors

In addition to the historical returns of both stocks and bonds, other considerations factor into the 4% rule. One of these is your life expectancy, since those who live longer need their portfolios to last longer. Medical costs and some other expenses also tend to increase as you age, so Bengen factored that into the 4% rule too.

One of the biggest factors that can impact the 4% rule is inflation. The rule is flexible in that it allows retirees to increase the rate at which they withdrawal funds from their portfolio in order to keep pace with inflation. Ways to adjust for inflation include setting a flat annual increase of 2% each year, which is the U.S. Federal Reserve’s target inflation rate. Alternatively, they can adjust withdrawals based on actual posted inflation rates. These methods enable retirees to effectively match their income to increases in the cost of living.

When The Rule Doesn’t Work

There are some scenarios in which the 4% rule might not work. A severe or prolonged market downturn, for example, can erode the value of a person’s investments. The 4% rule also doesn’t work unless you strictly adhere to it. Violating the rule once to splurge on a major purchase (maybe a new car or installing a pool) can lead to long-term financial consequences. These type of spending sprees reduce the principal, which directly impacts the compound interest that rule depends on for sustainable savings.

Proven Over Time

Some financial experts consider the 4% rule to be overly conservative. They continue to espouse that you can actually take more from your retirement fund each year. It all depends on how much money you have accumulated. Bengen developed the rule to take into account the worst possible economic situations, such as the 1929 and 1987 stock market crashes. So if the economy isn’t going through dire straits, some analysts say the 4% is too low.

Whether the 4% rule ultimately works for depends on a few things. Your retirement age, health, financial discipline, and overall investment amount all play a part. However, the 4% rule has held up remarkably well in the nearly 30 years since it was created. It’s helped countless retirees through the two most recent financial crises — the 2000 technology bubble bursting and the 2008 housing crisis. A retiree who adhered to the 4% rule during the 2008-09 crash is still doing better financially than those from earlier market crashes, according to financial industry studies. The economic downturn in 2020 due to the pandemic was yet another test of the 4% rule.

The Bottom Line

Retiring with financial security is everyone’s goal. Having a safe and reliable source of income to live in your elder years is critical to any retirement plans. The 4% rule can help. It’s a proven way to withdraw money from your savings without exhausting them in their lifetime.

Like all rules, though, there are exceptions to this one. It may indeed be too conservative if you managed to save a substantial next egg. On the other hand, if you didn’t save nearly enough, you might find yourself forced to take out more than 4% just to make ends meet. That will create future problems for yourself, but you still have to afford to live, right?

A prudent approach is often the best approach when it comes to financial security in retirement. Talk to a qualified financial expert about whether the 4% rule would be the right approach for you.

four percent 4% retirement rule

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Devon Taylor

Managing Editor

Devon is an experienced writer and a father of three young children. He's simultaneously trying to build college funds and plan for an eventual retirement. He's been in online publishing since 2013 and has a degree from the University of Guelph. In his free time, he loves fanatically following the Blue Jays and Toronto FC, camping with his family, and playing video games.

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