For a long time, the 4% rule was one of the most trusted pieces of financial advice. The idea was that if you wanted to retire and maintain your lifestyle without running out of money, you should withdraw no more than 4% of your retirement savings each year. But with the recent market turmoil, changes to interest rates, and rising inflation, is this still true? Here is why it may no longer be.
The 4% rule explained
The 4% rule was first coined in 1994 by financial advisors William Bengen. According to his research, withdrawing no more than 4% of your retirement savings each year would give you enough money for 30 years of retirement without running out of funds. That means if you have $1 million saved for retirement, you could withdraw $40,000 a year and not worry about depleting your nest egg.
What has changed?
In the 30 years since the 4% rule was introduced, there have been some major changes that make it less reliable today. One big factor is inflation. The average U.S. inflation rate since 1913 has been 3.1%. With inflation hitting as high as 9.1% this past summer and currently at 6.5%, withdrawals under the 4% rule will increase considerably. Retirees now need more money just to maintain their lifestyle. This means their investment portfolios will need to earn higher returns or the portfolio will quickly be depleted.
Another issue is market volatility. With the increase in interest rates, Wall Street has taken a beating the past 12 months, at one point entering bear market territory. The S&P 500 was down close to 20% in 2022, while the Nasdaq fell 34%. Despite the market downturn, stocks are still trading at about 36 times corporate earnings over the past decade -- double the historical average. This means that there may be more room for prices to fall. In addition, there may be an economic recession in the near future, adding more economic uncertainty to the future. During these periods, retirees will need to be even more cautious about making withdrawals to ensure they don't run out of money.
A better rule?
Due to these factors -- as well as longer life expectancies -- even Bengen himself has stated that in today's unprecedented economic situation, retirees will need to lower their withdrawal rate and cut back their spending. A recent Morningstar study shows that the 4% withdrawal rate is too aggressive, and retirees should start at a 3.3% withdrawal rate.
This lower rate gives retirees more cushion against inflation and market uncertainty so they won't run out of money too soon. In addition, if you're retiring, you should look at multiple sources of income during retirement -- such as Social Security benefits or pension payments -- so you aren't dependent on withdrawals from your retirement accounts. The key is to be flexible with your personal finances and keep a long-term financial view.
The traditional 4% rule has served retirees well for decades but may no longer be relevant due to rising costs and increased market volatility. Retirees should consider using a rate closer to 3.3% withdrawal rate instead, as well as looking into other sources of income. By doing this, retirees can ensure they don't run out of money during retirement.
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FAQs
Withdrawing 4% or less of retirement savings each year has long been a popular rule of thumb for retirees. However, due to high inflation and market volatility, the rule is less reliable now. Retirees will need to decrease their spending and withdrawal rate to 3.3% so they don't run out of money.
Why doesn't the 4% rule no longer work for retirees? ›
"It's not efficient." The 4% rule aims to minimize the risk of failure (running out of money) by being very conservative with spending early in retirement. However, this comes at the cost of potentially underutilizing one's savings and not being able to spend more if investment returns are favorable.
What are the flaws of the 4% rule? ›
If you want to be 100% sure you won't run out of money, following the 4% rule likely isn't the best choice. Not only is it an older rule, but it also doesn't account for changing market conditions. In a recession, it's probably not wise to step up your withdrawal amounts; you may even want to reduce them slightly.
How long will $1 million last in retirement? ›
Around the U.S., a $1 million nest egg can cover an average of 18.9 years worth of living expenses, GoBankingRates found. But where you retire can have a profound impact on how far your money goes, ranging from as a little as 10 years in Hawaii to more than than 20 years in more than a dozen states.
How long will money last using the 4 rule? ›
This rule aims to provide retirees high confidence that they won't outlive their savings for 30 years. Though popular, it has faced criticism in recent years due to forecasts for lower returns on investments. But some financial experts say that the 4% rule may be safe again due to higher bond yields.
How many people have $1,000,000 in retirement savings? ›
In fact, statistically, around 10% of retirees have $1 million or more in savings. The majority of retirees, however, have far less saved.
What percentage of retirees have $2 million dollars? ›
According to EBRI estimates based on the latest Federal Reserve Survey of Consumer Finances, 3.2% of retirees have over $1 million in their retirement accounts, while just 0.1% have $5 million or more.
At what age can you retire with $500,000? ›
If you withdraw $20,000 from the age of 60, $500k will last for over 30 years. Retirement plans, annuities and Social Security benefits should all be considered when planning your future finances. You can retire at 50 with $500k, but it will take a lot of planning and some savvy decision-making.
What percentage of retirees have $3 million dollars? ›
Specifically, those with over $1 million in retirement accounts are in the top 3% of retirees. The Employee Benefit Research Institute (EBRI) estimates that 3.2% of retirees have over $1 million, and a mere 0.1% have $5 million or more, based on data from the Federal Reserve Survey of Consumer Finances.
How much money do you need to retire comfortably at age 65? ›
Some strategies call for having 10 to 12 times your final working year's salary or specific multiples of your annual income that increase as you age. Consider when you want to retire, goals, annual salary, expected annual raises, inflation, investment portfolio performance and potential healthcare expenses.
Housing—which includes mortgage, rent, property tax, insurance, maintenance and repair costs—is the largest expense for retirees. More specifically, the average retiree household pays an average of $17,472 per year ($1,456 per month) on housing expenses, representing almost 35% of annual expenditures.
What is a good monthly retirement income? ›
Many retirees fall far short of that amount, but their savings may be supplemented with other forms of income. According to data from the BLS, average 2022 incomes after taxes were as follows for older households: 65-74 years: $63,187 per year or $5,266 per month. 75 and older: $47,928 per year or $3,994 per month.
At what age is 401k withdrawal tax free? ›
The IRS allows penalty-free withdrawals from retirement accounts after age 59½ and requires withdrawals after age 72. (These are called required minimum distributions, or RMDs). There are some exceptions to these rules for 401(k) plans and other qualified plans.
Is the 4% retirement rule making a comeback? ›
Thanks to higher interest rates and bond yields, it is likely safe for new retirees to spend 4% of their nest eggs in their first year of retirement and then to adjust that amount for inflation in subsequent years, according to a new analysis from Morningstar released Monday.
What is the $1000 a month rule for retirement? ›
One example is the $1,000/month rule. Created by Wes Moss, a Certified Financial Planner, this strategy helps individuals visualize how much savings they should have in retirement. According to Moss, you should plan to have $240,000 saved for every $1,000 of disposable income in retirement.
Does the 4% rule work for early retirement? ›
The 4% rule can be a good start for retirees, but it most likely needs to be fine-tuned for the F.I.R.E. movement. The rule was conceived for a traditional retiree facing a retirement horizon of 30 years (Bengen, 1994), not for an early retiree who may spend over 50 years in retirement. 1 See Vanguard (2020a).
What is the new law affecting retirement accounts? ›
The SECURE 2.0 Act of 2022 (SECURE 2.0) became law on December 29, 2022. The new law makes sweeping changes to 401(k) plans – particularly plans sponsored by small businesses. It includes provisions intended to expand coverage, increase retirement savings, and simplify and clarify retirement plan rules.
