What is the 4% Rule?

Your complete guide to retirement withdrawal strategies. Learn how the 4% rule works and discover strategies to make your retirement savings last.

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The 4% rule is a retirement withdrawal strategy that suggests you can safely withdraw 4% of your initial retirement portfolio balance in the first year, then adjust that amount for inflation each subsequent year (to maintain standard of living), with a high probability that your money will last for 30 years.

Simple Example:

If you retire with $1,000,000 saved, you can withdraw $40,000 in your first year. If inflation is 2%, you'd withdraw $40,800 in year 2, $41,616 in year 3, and so on.

This rule was developed by financial planner William Bengen in 1994 and later popularized by the Trinity Study. It's based on historical market data and provides a systematic approach to retirement income planning.

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The 4% rule emerged from groundbreaking research in the 1990s that sought to answer a fundamental question:"How much can I safely withdraw from my retirement portfolio without running out of money?"

William Bengen's Research (1994)

Financial planner William Bengen analyzed historical data from 1926-1995 and found that a 4% initial withdrawal rate, adjusted for inflation, would have survived all 30-year periods in the historical record.

The Trinity Study (1998)

Professors Philip Cooley, Carl Hubbard, and Daniel Walz expanded on Bengen's work, testing various withdrawal rates and asset allocations. Their research confirmed that 4% was indeed a safe withdrawal rate for most historical scenarios.

The research was based on a portfolio of 50% stocks and 50% bonds, rebalanced annually. The studies looked at rolling 30-year periods, testing how different withdrawal rates would have performed during various market conditions, including the Great Depression and the 1970s inflation.

Step 1: Determine Your Portfolio Value

Add up all your retirement accounts: 401(k), IRA, taxable investments, etc. This is your starting portfolio value.

Step 2: Calculate First Year Withdrawal

Multiply your portfolio value by 0.04 (4%). This is your safe withdrawal amount for the first year.

Step 3: Adjust for Inflation

Each subsequent year, increase your withdrawal by the inflation rate to maintain purchasing power.

Step 4: Monitor and Adjust

Regularly review your portfolio performance and consider adjusting withdrawals based on market conditions.

Example Calculation:

Portfolio Value: $1,000,000

First Year Withdrawal: $1,000,000 × 0.04 = $40,000

Year 2 (2% inflation): $40,000 × 1.02 = $40,800

Year 3 (2% inflation): $40,800 × 1.02 = $41,616

Dynamic Withdrawal Strategies

Adjust your withdrawal rate based on market performance. Reduce withdrawals during poor market years and increase them during good years.

Bucket Strategy

Divide your portfolio into buckets: cash for 1-2 years, bonds for 3-10 years, and stocks for long-term growth. This helps manage sequence of returns risk.

Guardrails Approach

Set upper and lower limits for withdrawals. If your portfolio grows significantly, you can increase withdrawals. If it shrinks, reduce withdrawals.

Income Floor Strategy

Combine guaranteed income sources (Social Security, pensions, annuities) with portfolio withdrawals to create a more stable retirement income stream.

Conservative Adjustments:

  • • Use 3-3.5% instead of 4% for more conservative planning
  • • Maintain a higher allocation to bonds early in retirement
  • • Keep 1-2 years of expenses in cash
  • • Consider working part-time during the first few years
  • • Delay Social Security to increase guaranteed income

Historical Data Limitations

The 4% rule is based on historical data from 1926-1995. Future market conditions may differ significantly from this period, especially given current low interest rates and high valuations.

Sequence of Returns Risk

Poor market performance in the first few years of retirement can devastate a portfolio's long-term prospects, even if average returns over the entire period are good.

Inflation Risk

Unexpected high inflation can erode purchasing power faster than the portfolio can keep up, especially if inflation-adjusted withdrawals are maintained.

Longevity Risk

Living longer than 30 years means the portfolio needs to last longer than the original research period, requiring more conservative withdrawal rates.

Tax and Fee Considerations

The original research didn't account for taxes, investment fees, or other costs that can reduce actual portfolio returns and withdrawal amounts.

Modern Considerations

Current low interest rates, high stock valuations, and potential for lower future returns suggest that the 4% rule may need to be adjusted downward to 3-3.5% for today's retirees.

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