For a long time, the 4% rule was one of the most trusted pieces of financial advice. The idea was that if you wanted to retire and maintain your lifestyle without running out of money, you should withdraw no more than 4% of your retirement savings each year. But with the recent market turmoil, changes to interest rates, and rising inflation, is this still true? Here is why it may no longer be.
The 4% rule explained
The 4% rule was first coined in 1994 by financial advisors William Bengen. According to his research, withdrawing no more than 4% of your retirement savings each year would give you enough money for 30 years of retirement without running out of funds. That means if you have $1 million saved for retirement, you could withdraw $40,000 a year and not worry about depleting your nest egg.
What has changed?
In the 30 years since the 4% rule was introduced, there have been some major changes that make it less reliable today. One big factor is inflation. The average U.S. inflation rate since 1913 has been 3.1%. With inflation hitting as high as 9.1% this past summer and currently at 6.5%, withdrawals under the 4% rule will increase considerably. Retirees now need more money just to maintain their lifestyle. This means their investment portfolios will need to earn higher returns or the portfolio will quickly be depleted.
Another issue is market volatility. With the increase in interest rates, Wall Street has taken a beating the past 12 months, at one point entering bear market territory. The S&P 500 was down close to 20% in 2022, while the Nasdaq fell 34%. Despite the market downturn, stocks are still trading at about 36 times corporate earnings over the past decade -- double the historical average. This means that there may be more room for prices to fall. In addition, there may be an economic recession in the near future, adding more economic uncertainty to the future. During these periods, retirees will need to be even more cautious about making withdrawals to ensure they don't run out of money.
A better rule?
Due to these factors -- as well as longer life expectancies -- even Bengen himself has stated that in today's unprecedented economic situation, retirees will need to lower their withdrawal rate and cut back their spending. A recent Morningstar study shows that the 4% withdrawal rate is too aggressive, and retirees should start at a 3.3% withdrawal rate.
This lower rate gives retirees more cushion against inflation and market uncertainty so they won't run out of money too soon. In addition, if you're retiring, you should look at multiple sources of income during retirement -- such as Social Security benefits or pension payments -- so you aren't dependent on withdrawals from your retirement accounts. The key is to be flexible with your personal finances and keep a long-term financial view.
The traditional 4% rule has served retirees well for decades but may no longer be relevant due to rising costs and increased market volatility. Retirees should consider using a rate closer to 3.3% withdrawal rate instead, as well as looking into other sources of income. By doing this, retirees can ensure they don't run out of money during retirement.
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FAQs
The 4% rule entails withdrawing up to 4% of your retirement in the first year, and subsequently withdrawing based on inflation. Some risks of the 4% rule include whims of the market, life expectancy, and changing tax rates. The rule may not hold up today, and other withdrawal strategies may work better for your needs.
Why does the 4 rule no longer work for retirees? ›
It's a rigid rule.
It also assumes you never have years where you spend more, or less, than the inflation increase. This isn't how most people spend in retirement. Expenses may change from one year to the next, and the amount you spend may change throughout retirement.
Is the 4% retirement rule making a comeback? ›
Ivanna Hampton: New retirees could kick off their golden years with a familiar number, 4%. A trio of Morningstar researchers analyzed starting safe withdrawal rates from an investment portfolio to fund retirement. The future looks good, and a little flexibility could make it even better.
How long will money last using the 4% rule? ›
This rule is based on research finding that if you invested at least 50% of your money in stocks and the rest in bonds, you'd have a strong likelihood of being able to withdraw an inflation-adjusted 4% of your nest egg every year for 30 years (and possibly longer, depending on your investment return over that time).
Is a 4 withdrawal rate still a good retirement rule of thumb? ›
Although market conditions have put the “four” back in the 4% rule, that's just the starting point for retirees crafting their withdrawal strategies. “The 4% rule is meant to be a rule of thumb and not a financial plan,” says Brendan McCarthy, head of retirement investing for Nuveen.
What is the flaw with the 4% rule? ›
What are some pros and cons of the 4% rule?
| Pros | Cons |
|---|
| The rule is simple to follow | It isn't dynamic enough to respond to lifestyle changes |
| You'll have predictable, steady income | The 4% rule doesn't respond to market conditions |
2 more rowsWhat are the main criticisms of the 4% rule? The rule ignores the performance of an individual's portfolio. Indeed, it assumes you up your spending every year by the rate of inflation — rather than by how your portfolio performed — which may cause issues for some investors.
What is the Biden retirement rule? ›
“This rule protects the retirement investors from improper investment recommendations and harmful conflicts of interest. Retirement investors can now trust that their investment advice provider is working in their best interest and helping to make unbiased decisions.”
What is the 5% retirement rule? ›
As an estimate, aim to withdraw no more than 4% to 5% of your savings in the first year of retirement, then adjust that amount every year for inflation.
What is the 3% rule in retirement? ›
What is the 3% rule in retirement? The 3% rule in retirement says you can withdraw 3% of your retirement savings a year and avoid running out of money. Historically, retirement planners recommended withdrawing 4% per year (the 4% rule).
However, not a huge percentage of retirees end up having that much money. In fact, statistically, around 10% of retirees have $1 million or more in savings. The majority of retirees, however, have far less saved.
What is the average 401k balance for a 65 year old? ›
How long will $300,000 last for retirement? ›
Summary. $300,000 can last for roughly 26 years if your average monthly spend is around $1,600. Social Security benefits help bolster your retirement income and make retiring on $300k even more accessible. It's often recommended to have 10-12 times your current income in savings by the time you retire.
How long will $500,000 last in retirement? ›
Yes, it is possible to retire comfortably on $500k. This amount allows for an annual withdrawal of $20,000 from the age of 60 to 85, covering 25 years. If $20,000 a year, or $1,667 a month, meets your lifestyle needs, then $500k is enough for your retirement.
How long will $400,000 last in retirement? ›
Safe Withdrawal Rate
Using our portfolio of $400,000 and the 4% withdrawal rate, you could withdraw $16,000 annually from your retirement accounts and expect your money to last for at least 30 years. If, say, your Social Security checks are $2,000 monthly, you'd have a combined annual income in retirement of $40,000.
What is the average net worth of a 70 year old? ›
Average net worth by age
| Age by decade | Average net worth | Median net worth |
|---|
| 40s | $713,796 | $126,881 |
| 50s | $1,310,775 | $292,085 |
| 60s | $1,634,724 | $454,489 |
| 70s | $1,588,886 | $378,018 |
4 more rows(updated March 14, 2023) You must take your first required minimum distribution for the year in which you reach age 72 (73 if you reach age 72 after Dec. 31, 2022). However, you can delay taking the first RMD until April 1 of the following year.
What is the new law affecting retirement accounts? ›
The SECURE 2.0 Act of 2022 (SECURE 2.0) became law on December 29, 2022. The new law makes sweeping changes to 401(k) plans – particularly plans sponsored by small businesses. It includes provisions intended to expand coverage, increase retirement savings, and simplify and clarify retirement plan rules.
How much does Suze Orman say you need to retire? ›
Suze Orman is right. In order to retire early, you need at least $5 million in investable assets. With interest rates so low, it takes a lot more capital to generate the same amount of risk-adjusted income.
