Four Percent Rule

What it is

The 4% rule is a simple retirement-withdrawal guideline: withdraw 4% of your retirement account balance in the first year of retirement and then increase that dollar amount each subsequent year to keep pace with inflation. The rule was designed to provide a steady income stream while preserving portfolio longevity—originally aimed at lasting about 30 years.

Example: With $1,000,000 saved, a 4% withdrawal equals $40,000 in year one. If inflation is 2% that year, you would withdraw $40,800 in year two.

How it works

• Start by withdrawing 4% of your initial portfolio value in year one.
• Each following year, increase the withdrawn dollar amount by inflation (either actual inflation or a chosen fixed rate).
• The approach relies on investment returns (interest, dividends, capital gains) to replenish or maintain the portfolio so withdrawals remain sustainable over the intended time horizon.

Origins and assumptions

• Created by financial adviser Bill Bengen in the mid-1990s after testing historical U.S. stock and bond returns (1926–1976), including severe downturns.
• Bengen found no historical case in his sample where a 4% initial withdrawal exhausted a balanced portfolio in fewer than ~33 years.
• Typical portfolio assumptions underlying the rule are balanced allocations (historically cited examples include 50/50 or 60/40 stock/bond mixes).

Adjusting for inflation

Two common approaches to inflation adjustments:
– Use actual annual inflation to increase the withdrawal amount, matching cost-of-living changes.
– Use a fixed annual increase (for example, 2%), which provides predictability but may diverge from real purchasing power.

Pros and cons

Pros
– Simple and easy to follow.
– Produces a predictable, steady income stream.
– Historically provided a high probability that savings would last for the target horizon.

Cons
– Based on historical market performance—past results don’t guarantee future outcomes.
– Requires strict adherence; large one-time overspending can undermine sustainability.
– May be too aggressive or too conservative depending on market conditions, interest rates, and individual circumstances.
– May not suit early retirees whose retirement horizon exceeds ~30 years.

Variations and expert views

• Some experts argue that current low bond yields and other market conditions justify a lower safe withdrawal rate (e.g., 3%).
• Others—including Bengen in some comments—have suggested that in many historical scenarios a 5% rate might have been feasible, though that raises longevity risk.
• Adjustments to the rule often reflect portfolio allocation, retirement length, expected returns, and personal risk tolerance.

Performance in downturns

The 4% rule was tested against historical downturns (including the Great Depression and stagflation of the 1970s) and generally performed acceptably across those scenarios. That said, sequencing risk—suffering large losses early in retirement—can materially increase the chance of depletion, so many planners counsel caution when markets are depressed at retirement start.

Suitability and limits

• Designed for an approximate 30-year retirement horizon; it may not be appropriate for early retirees planning for 40+ years of withdrawals.
• Individual factors that may require modification: expected lifespan, health care costs, pension/Social Security timing, tax status, and changing spending needs.
• Portfolio allocation should be reconsidered in retirement; many retirees reduce equity exposure and increase cash or bond holdings, which affects sustainable withdrawal rates.

Practical recommendations

• Use the 4% rule as a starting point or rule of thumb, not an absolute prescription.
• Reassess withdrawals regularly (annually or when your financial picture changes) and consider dynamic withdrawal strategies that reduce withdrawals after poor market years.
• Discuss plans with a financial planner to tailor the withdrawal rate to your portfolio, time horizon, and risk tolerance.
• Maintain an emergency or cash reserve to avoid forced selling during market downturns.

Bottom line

The 4% rule offers a straightforward framework for planning retirement withdrawals and has historical support for roughly 30-year retirements. However, it is not one-size-fits-all. Adjust the rule for your time horizon, portfolio mix, and the current economic environment, and revisit the plan regularly.