For many Americans, planning for retirement can feel overwhelming. One of the most common questions is “How much can I withdraw each year and still make my money last?” The 4% rule was created to help answer this question in a straightforward way, but recent developments suggest it may need adjustments to fit today’s financial environment. Not familiar with the 4% rule? Check out this episode of the Winning at Life Financial Podcast with Gregory Ricks: https://youtu.be/PuovjMhQgEU?si=99XmotOwvfhm2DwT
What is the 4% Rule?
The 4% rule is a theoretical guideline for retirees to determine how much of their savings they can withdraw with minimal each year. Essentially, the “rule” theorizes a retiree can withdraw 4% of their retirement portfolio in their first year of retirement. Each subsequent year, the retiree would increase the withdrawal amount based on inflation to maintain their purchasing power. This strategic approach was intended to help prospective retirees’ savings last for at least 30 years.
So, for a hypothetical example: if Vince retires with $1,000,000 in savings, the 4% rule suggests withdrawing $40,000 in his first year. In the following years, Vince would adjust that amount according to inflation.
If we expand that theoretical concept, assume this: Vince retires in 2023 and the first withdrawal is $40,000. In 2024, he checked the most recent inflation data from the Bureau of Labor Statistics (BLS). According to the BLS CPI latest numbers, let’s say the annual inflation rate reported for 2023 was 3.5%. To keep up with rising costs, Vince would increase his 2025 withdrawal by 3.5%. The formulaic breakdown is:
Multiply the initial withdrawal by the inflation rate:
$40,000 x 3.5% = $1,400
Then, add this increase to the previous withdrawal:
$40,000 + $1,400 = $41,400
So, in the second year of retirement, Vince would withdraw $41,400. Each year going forward, Vince would check the latest CPI data and make similar adjustments, so he has a better chance of keeping his retirement income withdrawal pace in line with the cost of living. (However, if you decide to use Gregory Ricks Total Wealth as your advisory firm, we’ll do those calculations for you.) Staying updated with the official CPI numbers from the BLS allows one to tailor their retirement withdrawals based on actual inflation, helping one maintain as much of their possible purchasing power throughout retirement.
Origins of the Rule
Financial planner William Bengen introduced the 4% rule in 1994. He used historical market data and assumed a balanced portfolio made up of 50% stocks and 50% bonds. His studies showed that even during challenging periods like the Great Depression and the high-inflation 1970s, withdrawing 4% annually would typically allow retirees to avoid running out of money over a 30-year retirement.
Why the Rule is Changing
A lot has changed since the 1990s. People live longer, health care costs continue to rise, and investment returns are less predictable than in the past. Today’s retirees also face greater risks from tax law changes, inflation, and market volatility. All of these factors are important to consider when setting up a withdrawal strategy.
In recent years, Bengen himself has stated that the 4% rule may be too conservative for some. According to his new research, using a more diversified portfolio that includes small-cap stocks could allow for a slightly higher withdrawal rate, possibly closer to 4.5% in some cases. However, this does not mean every retiree should immediately increase their withdrawals. Each situation is unique and depends on many personal factors.
The Role of Sequence of Returns
When you retire and start withdrawing funds, the order of investment returns matters a lot. For example, two people retiring with the same amount of money but in different years can have dramatically different outcomes, especially if one of them retires right before a market downturn. This risk, known as “sequence of returns risk,” means that poor market performance early in retirement can significantly reduce how long your savings will last.
More than Just the Percent
The 4% rule provides a useful starting point, but it is not the entire retirement income strategy. Health care expenses, long-term care needs, and unexpected emergencies can impact any plan. Taxes are another crucial consideration since they can change both during retirement and throughout your lifetime. Different retirement savings vehicles, such as 401(k)s, Roth IRAs, and taxable accounts, each have specific tax treatments.
A Holistic Approach
Strategists now recommend taking a more comprehensive approach to retirement planning. This might include insurance products that provide guaranteed income for life, legacy protection, and tax advantages. It can also mean working with an advisor to develop a personalized withdrawal rate based on your individual needs, goals, and risk tolerance. Periodically reviewing your plan ensures you adjust for changing tax laws, investment returns, or personal circumstances. The 4% rule was designed to simplify retirement withdrawals, and it continues to serve as a helpful guideline. However, it should not be the sole strategy for managing your retirement income.
This article is meant to be general and is not investment or financial advice or a recommendation of any kind. The opinions and other information contained in this article are subject to change based on the market or other conditions. Please consult your financial advisor before making financial decisions. For more detailed information, contact a financial advisor with Gregory Ricks & Associates, Inc. Investment advisory products and services through AE Wealth Management, LLC. (AEWM). Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with aqualified professional for guidance before making any purchasing decisions. 4197958 – 7/26