Does the 4% Rule Work? What Financial Advisors Say

Upon retirement, you may wonder how much money you should begin drawing from your various plans and accounts. Often mentioned by financial advisors and experts, the 4% rule is a curated method of withdrawing funds after you retire. It involves taking out 4% of your retirement funds beginning in the first year after retirement. But how well does it work in today’s financial landscape?

In this article, we’ll examine whether the 4% withdrawal rule is still all it’s cracked up to be today, including an analysis of its notable benefits, shortcomings, and misconceptions surrounding the concept. To do so, we’ll introduce the perspectives and insights of four financial advisors and experts who have spent significant time working in the industry.

What Is the 4% Rule?

The 4% rule is a common rule of thumb experts recommend intended to help people figure out how much money to withdraw in retirement. Specifically, it says you must withdraw 4% of your saved funds each year, starting the first year after retirement.

The rule “is based on a 30-year time horizon and a portfolio made up of 50% stocks and 50% bonds,” says Chris Urban, CFP, RICP, founder of Discovery Wealth Planning. “The theory goes that you can withdraw 4% of your total portfolio amount in year one and then adjust that amount by the inflation rate each year for subsequent year withdrawals, all while having a close to zero chance of running out of money,” he explains.

For example, consider that you’ve saved up $2 million across your various retirement plans and accounts. Per the 4% rule, you would withdraw $80,000 in the first year after leaving your job. Then, as Urban outlines, you would adjust the amount you take out in subsequent years to account for inflation. If you assumed a 2% inflation rate, you would adjust your withdrawal amount to $81,600 in the next year.

When asked how he would characterize it to clients, Scott Neu, AIF, financial advisor at Reinke Gray Wealth Management, says, “The 4% rule provides retirees with a straightforward strategy for managing their withdrawals, helping to maintain a balance between enjoying their retirement lifestyle and preserving their savings for the long term. By adjusting for inflation, it helps retirees keep pace with rising living costs over time.”

It’s Simple and Easy to Follow

The primary advantage of the 4% rule is its straightforward and relatively easy-to-follow nature. As mentioned, it involves taking out a fixed amount from your overall portfolio value and adjusting it yearly to factor in inflation. This allows you to be able to have an expected income as you enter and progress into your post-working years.

According to Andrew Latham, a certified financial planner (CFP) and director of content at SuperMoney.com, “The main advantage of the 4% rule is its simplicity and ease of use, providing a clear framework for planning retirement withdrawals.”

The simplicity, as Latham says, and rigidity of the rule — a strict 4% — can be beneficial for those who feel overwhelmed by more subjective calculations on how much money to take out for retirement. Ultimately, if you grasp the percentages or have a financial advisor’s help, you can follow the rule without any problems.

Rigidity Can Be the Rule’s Downfall

While the 4% rule creates a defined withdrawal blueprint individuals can follow years into their retirement, its chief benefit can also be its detriment. Specifically, its rigidity can mean it may not suit every retiree’s situation or, in other cases, keep up with changing market conditions.

To this point, Urban says, “While an OK starting point, [the 4% rule] is a pretty inflexible approach to retirement spending.” He continues, “Retiree spending can vary dramatically, based notably on things such as travel and healthcare. This could mean more spending early and later in retirement with a decrease in the middle years. Additionally, most people want to adjust their spending based on changing life goals including gifting, legacy, etc.”

Hardly ever is anything in finance one-size-fits-all, with different strategies applying to varying degrees of goals and risk tolerance people have. You may end up having needs in retirement that could surpass or, perhaps, take a big chunk out of the fixed amount you intend to take out by following the 4% rule.

Additionally, while the rule allows for adjustments for inflation, it might not keep pace with market volatility. Latham says, “A drawback of the 4% rule is that it may not account for market conditions, extended periods of high inflation, or major changes in personal circumstances, which could lead you to run out of money sooner than expected.” He continues, “The rule assumes an average annual return on investment (ROI) of around 7%, which may not always be realistic due to market volatility.”

Potential of Underspending

Another pitfall of the 4% rule is that it may not enable you to spend enough of the money you’ve saved up for retirement. Though the rule assumes a 30-year window to withdraw money and spend it on various uses, some advisors argue that this may be too conservative for some individuals.

Urban notes that while factors such as the time of one’s passing and “sequence of investment returns” can affect the result, “many people end up with more money than they started with, essentially not spending nearly as much as they could have.” Needs may vary significantly, and some people may not spend nearly enough of the 4% they withdraw. This could be due to any number of reasons, such as fear of overspending or simply less of a desire or need to substantially dip into retirement funds.

Robert R. Johnson, PhD, CFA, CAIA, Professor of Finance, Heider College of Business, Creighton University, points out that while the 4% rule provides a roadmap for withdrawing savings, it may not be the simple solution some people think it is:

Retirement spending is more difficult than one often considers. Too often investors focus on the accumulation stage and ignore the decumulation stage. Ironically, the biggest money move that many financial advisors have trouble mastering is spending retirement savings. People focus all their lives on accumulating savings and then struggle with spending those savings. The biggest fear for many investors is the fear of running out of money in retirement. People search for a simple guide on the decumulation stage. The widely employed and recently debunked 4 percent rule is an example.

Problematic for Early Retirees

If you’re an early retiree, the 4% rule may not be the most ideal strategy. This is because, as noted, it generally accounts for a 30-year withdrawal period. Naturally, if you leave your job ahead of most other people, you’ll likely have a much longer retirement horizon, meaning you’ll need to conserve your savings over a greater period.

If you take the 4% out beginning at, for instance, age 50, you run the risk of exhausting your money too quickly. Per Neu, “Those who retire early or have fluctuating income streams may need to adjust their withdrawal strategy accordingly to ensure financial security throughout retirement.”

Misconceptions of Guaranteed Income

According to Latham, one of the most prominent misconceptions surrounding the 4% rule “is that it guarantees your money will last exactly 30 years regardless of circumstances.” However, as he points out, this is not the case. Rather, the longevity of your savings relies on a mix of factors, including how well-invested your portfolio is.

“In reality, the rule is based on historical data assuming an average annual return of around 7%, which may not be achievable with every portfolio,” Latham says. “To make the 4% rule work effectively, you need a well-diversified portfolio with a balanced mix of stocks, bonds, and other assets to manage risk and optimize returns. Relying on a portfolio that’s too conservative may not generate sufficient growth, while one that’s too aggressive could expose you to significant market downturns,” he emphasizes.

Bottom Line

The 4% rule is a basic way for people who have reached retirement age to determine how much money they should take out each year. Its simplicity makes it accessible, especially to those who are unsure where to start.

The rule, however, comes with its set of critical disadvantages, most notable of which is its oversimplification for something that requires more of a customized approach that fits each person’s unique needs in retirement, as well as the potential to not keep up with market shifts. As an alternative, Urban recommends a more flexible strategy:

In my opinion, it is much better to have a dynamic spending approach for retirement. A risk-based guardrails approach can change over time with a retiree based on changing investment portfolio returns, longevity, legacy and life goals. Retirees have the ability to be flexible with their spending, increasing or decreasing discretionary expenses as needed. It’s not simply “success” or “failure”. This approach often ends up with clients being able to spend much more than they would otherwise think with approaches such as the “4% Rule”.