The 4% Rule: Is It Still A Safe Withdrawal Rate For Retirement?

Shawn Plummer

CEO, The Annuity Expert

As pensions have continued to be a less common source of retirement income, it has become necessary to develop alternative retirement income approaches. Ask 100 people how much income your retirement nest egg can generate in retirement, and you will get 100 different answers. However, while there are different strategies and approaches, one rule of thumb is usually the basis from which all others are built, the 4% Withdrawal Rule.

But is Bengen’s 4% safe withdrawal rate still safe?

What Is The 4% Rule

In October 1994, financial advisor William Bengen published an article in the Journal of Financial Planning entitled “Determining Withdrawal Rates Using Historical Data.” His article set the stage for a debate many financial professionals still have today.

The study determined how many retirees could withdraw from their retirement nest egg without running out of money.

Bengen’s research concluded that for a 60-65-year-old retiree, a 50/50 allocation between stocks and bonds with a withdrawal rate of 4% of the initial portfolio value, adjusting annually for inflation, could generate retirement income for 30 years.

Today, however, researchers are beginning to rethink Bengen’s 1994 research. For example, many researchers believe a safe withdrawal rate isn’t 4%, but 2.8% or 2%, or even as low as 1.49%.

Why?

Bonds.

Simply put, Bengen’s research assumes that your retirement portfolio was invested in stocks and bonds, and Bengen’s assumptions did not consider today’s long period of historically low bond yields. His research also did not account for taxes, fees, or increased longevity.

The low yields drag down the potential performance of the bond portion of your portfolio lower than what Bengen assumed. And before you think that simply reducing your bond holdings will be the answer, increasing your exposure to stocks will increase your exposure to volatility, which adds a new level of risk to your retirement.

Is 4% A Safe Withdrawal Rate From Running Out Of Money?

How The 4% Rule Works

The 4% rule is a retirement strategy that says you can withdraw up to 4% of your portfolio’s value in the first year. For example, using this method, if you have saved $1 million for retirement, following the 4% rule would enable you to spend $40,000 during that initial year.

Every year of retirement, you can withdraw an amount based on the previous year’s withdrawal rate with readjustment for inflation. As an example, let’s say inflation was 2%. In that case, you could withdraw $40,800 ($40,000 x 1.02). On infrequent occasions when prices go down by a certain percentage (say 2%), you would withdraw less than what was allowed in the prior year–in our example, that would be $39,200 ($40,000×0.98). The dollar amounts being withdrawn each subsequent year are automatically adjusted to account for changes in inflation rates.

A frequent misunderstanding is that the 4% rule suggests that retirees withdraw 4% of their portfolio’s worth every year. The 4% applies exclusively to year one of retirement, though. Afterward, inflation controls the amount withdrawn to keep the purchasing power intact of what was withdrawn in the initial year of retirement.

Factoring In Fees

Bengen’s study did not factor how investment management fees could cut one’s returns if invested for a long time. Therefore, the small management fee should not impact Bengen’s results if you manage your investments using low-cost index funds. However, this rule may not apply to those who pay an investment advisor because their fees are usually around 4%.

Many investment advisors charge an annual fee of 1% of the assets they manage. However, if those same advisors pick actively managed mutual funds, which usually have annual fees of around 75 basis points or more, the total fees can get close to or exceed 2%. When high investment management fees like this hurt stock and bond returns, it causes problems for the 4% rule.

Challenges of Withdrawal Rates

In 2013, Morningstar published a report entitled “Low Bond Yields and Safe Portfolio Withdrawal Rates.” Its goal was to examine the impact of historically low bond yields on the success rates of different withdrawal rate strategies. Morningstar concluded that withdrawal rates would need to be significantly lower than 4% to have a high probability of success.

Alternatives to The 4 Percent Rule

Fixed index annuities (FIAs) may be one potential solution to address lower withdrawal rates. FIAs and annuities generally can provide more guaranteed income than a pure withdrawal rate strategy. 

FIAs are designed to be long-term vehicles that offer income benefit riders, which may be offered either built-in or, for an additional cost, can provide retirees with lifetime income.

The 4% Rule vs. Annuities

To see how you can potentially address this issue, consider Bill and Jill. Bill and Jill have $1 million saved and need $40,000 a year for retirement.

4% Withdrawal Rate

Bill planned to withdraw 4% of his portfolio to generate $40,000. However, based on recent research published by Morning Star, Bill would only have a 50% chance of having his money last 30 years. Alternatively, to have a 90% chance of having his money last for 30 years, he would have to lower his retirement withdrawals to $27,000.

Annuity

On the other hand, Jill elects to incorporate a fixed index annuity into her retirement strategy.

By using a portion of her $1 million to purchase a fixed index annuity, she can still reach her retirement income goal of $40,000. Plus, the income generated by the fixed index annuity can be guaranteed to generate lifetime income.

The key is to address the many retirement risks; you may need to consider retirement products that you may not have contemplated when you were saving for retirement.

Annuities are just one of these types of products that are specifically designed to help generate retirement withdrawals.

4 Percent Rule Calculator

As people live longer and healthier lives, retirement is no longer the brief respite from work it once was. Instead, for many people, retirement lasts 20 years or more. Given this new reality, planning carefully for retirement withdrawals is more critical than ever.

One of the best ways to efficient retirement spending is with an annuity. An annuity insurance policy will give you a guaranteed fixed income for the rest of your life, so you don’t have to worry about running out of money in retirement. An annuity can earn interest on your retirement plan without the risk of market volatility while collecting income. If you have any remaining balances when you die, they will be passed down to your beneficiaries as a death benefit. To see if this drawdown rule applies to you, use our safe withdrawal rate calculator to compare investment outcomes.

Note: You can purchase an annuity (with no tax penalties) with your 401(k), IRAs, retirement accounts, investments, cash, and retirement savings.

Safe Withdrawal Rate Comparison

Annuities automate the withdrawal process for your retirement savings. The table below compares the differences between using an annuity to distribute your retirement income versus systematically withdrawing from retirement plans yourself or through financial advisors using the rule for retirement.

FeaturesAnnuity401(k)IRARoth IRA
Withdrawal Percentage5.20% – 6.55%4%4%4%
Can Income Increase?YesYesYesYes
Can Income Decrease?NoYesYesYes
How Long Will Money Last?Lifetime30 Years+30 Years+30 Years+
Annual Fees0 – 1.50%1% – 4%1% – 4%1% – 4%
TaxationTaxable/Tax-FreeTaxableTaxableTax-Free
Death BenefitAccount BalanceAccount BalanceAccount BalanceAccount Balance

Example: A 60-year-old retiree starts withdrawing immediately from their $1 million portfolio, they would receive:

Next Steps

So, what is the takeaway from all of this?

First and foremost, depending on the 4% safe withdrawal rate to support you in retirement, you may be in for a rude awakening.

Second, it’s always essential to consult with a personal finance expert (like The Annuity Expert) when planning your retirement – someone who can help crunch the numbers and give you a realistic idea of how much money you will need to sustain your desired lifestyle.

Finally, at The Annuity Expert, we believe it’s never too early or too late to start planning for retirement, so please don’t hesitate to contact us for a quote. We would be happy to help!

Does The 4% Withdrawal Rule Work? (Four Percent Rule Safe Withdrawal Rate For Retirement)

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Frequently Asked Questions

How long will the money last using the 4% rule?

The 4% rule is a popular rule of thumb used to estimate how long retirement savings will last. It states that withdrawing and spending 4% of total portfolio value yearly should be enough to sustain an individual’s lifestyle without running out of money. Of course, the exact duration depends on the size of your retirement portfolio, but as a general guideline, if you withdraw 4% per year, you may have enough money to last for 25 years.

What is a safe withdrawal rate in retirement?

A safe withdrawal rate in retirement allows you to preserve your principal or original capital and still be able to withdraw an income from your investments. Generally, a safe withdrawal rate can range from 4-5% of your total investment portfolio. However, it is essential to note that this number could vary depending on your situation and financial goals.

What is the 4 rule for retirement?

The 4% rule is a popular retirement-saving rule that suggests withdrawing and spending 4% of your total portfolio value annually. This should be enough to sustain an individual’s lifestyle without running out of money. However, it is essential to remember that this strategy’s exact duration and success will depend on the size of your retirement portfolio, so it should be tailored to fit your unique needs.

How Long Will Money Last Using The 4% Rule?

How long your money will last using the 4% rule depends on the size of your retirement portfolio, the withdrawal rate you choose, and the rate of inflation. For example, if you have a $500,000 retirement portfolio and withdraw 4% ($20,000) in the first year of retirement, and the rate of inflation is 2%, your withdrawal rate would increase to 4.2% in the next year.
The rule of thumb is that using 4% withdrawal rate, the money should last for 25 years, however, it’s important to note that this is a rough estimate and actual results may vary based on the performance of your investments, changes in inflation, and other factors.

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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