Revisiting The 4% Rule

Retirees concerned about money

Do you remember the first time you climbed a tree?  I do; it was on a dare from my younger brother, Matt. I was the better part of nine years old and I remember carefully navigating the branches on the way up and the exhilarating feeling as I surveyed my neighborhood from above. Then it dawned on me that I needed to find my way down . . . safely. You know, the branches didn’t seem as sturdy on the way down and it was far more nerve-wracking than the climb up. And it didn’t help that my kid brother was staring at me, just waiting for me to fall.

This got me thinking.  I got thinking about how climbing a tree and planning for retirement can be similar. On the surface so much of our focus is on the climb up, right?  But once we reach retirement and get to actually realize the fruits of our climb, how we turn our savings into income becomes equally important. The income planning part, or the distribution phase, of retirement planning can create stress for even the most daring investor.  In fact, research shows that for those in or nearing retirement, running out of money in retirement is one of their biggest financial fears.  Nobel prize winning economist William Sharpe went so far as to describe retirement income spending as “the hardest and nastiest problem in finance.” 

For the last 25 years the “4% withdrawal rule” has been the benchmark for how retirees can safely spend down their retirement accounts. As the name implies, the rule tells retirees that they can withdraw a steady 4% per year from their retirement accounts for a 30-year duration and not run out of money. Bill Bengen created the rule in the mid-1990’s.  Bill’s a pretty interesting guy.  He is an MIT engineer who turned financial advisor.  Bill studied the use of a conservative portfolio of stocks and bonds and adjusting for rates of inflation over time. Using historical data Bengen showed that a 4% annual withdrawal rate from a conservative portfolio is generally sustainable. Over time the 4% rule gained broad acceptance in the financial industry as a rule of thumb, but not without naysayers.  While some folks swear by it, others reject it outright. The reality is, probably like any “rule of thumb” the 4% rule is a good guideline that needs to be adjusted for the individual involved. It can be a great starting point, but personal bias and the timing of someone’s retirement will impact what withdrawal rate is right for any one person.  Historical data can be very accurate but can never be a perfect predictor of the future.  

Feeling the 4% rule was too simplistic Bengen recently revisited it, adding more advanced data practices and newer economic modeling techniques. He focused on the relative importance of when you retire in relationship to the value of the stock market and current inflation. Using the same historical data, he found the minimum sustainable withdrawal rate was 4.5% and could be even higher when inflation remains low.  While it is not surprising that lower inflation helped increase the withdrawal rate, he was somewhat surprised that lower stock market valuations also indicated the ability to make larger withdrawals. Looking back over the past two decades, inflation has been relatively low, but stock market valuations (a company’s price to earnings ratio) have generally been on the rise since the great recession of 2008.

And then there are the critics of the 4% rule, who feel that it is outdated and overstates what retirees can safely withdraw throughout retirement. Some believe that, because the rule was developed using historical data available over 20 years ago, it’s less relevant to data available now or looking forward. Over the last several years, lower interest rates and low fixed-income yields have been a factor in retirement planning. Going forward, they may not produce suitable returns necessary to assure that 4% rule works over the long term.

I have found over the years that the best practice is coming up with your own benchmark and the 4% rule may be a good foundational number to start with. Personal experience and historical data can help us approach the right numbers, but no one can be fully assured of knowing the exact number of years they will live in retirement, what their average annual portfolio returns will be, what sequence of returns will produce those average return, what the inflation rate will be, or things like tax rates and large, unexpected expenses.  Remember folks, a sound retirement system is not about trying to predict, but always about being prepared. 

Because of the unknowns and ever-changing financial landscape, any chosen withdrawal rate needs to be reviewed on an annual basis and occasionally adjusted up or down. Being too aggressive with withdrawals can mean running out of money, being too conservative can cheat you out of the retirement you deserve.  

Just like climbing a tree as a kid, how far you climb up is optional, getting down is mandatory. 

So as always – be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield. Jeff can be reached at

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