The 4% Retirement Withdrawal Rule: What to Know

One of the most iconic rules of thumb in the financial planning world is the 4% rule. This rule, introduced by financial planning legend Bill Bengen in a 1994 paper, has been the benchmark withdrawal rate for retirees ever since.

The premise of Bengen’s research is that over a 30-year retirement, a retiree could safely withdraw assuming a starting withdrawal amount of 4% of his portfolio. For portfolios with 20% or more in equities, the success rate—the odds of not running out of money—was 90%.

Read on to find out if the 4% rule would work as a withdrawal strategy for you. (For related reading, see: Why the 4% Rule No Longer Works for Retirees.)

There has been some discussion in recent years as to whether the 4% rule is still valid or if this is something that retirees and their financial advisors can rely with certainty. To the latter point, I’m not entirely sure that Bengen or anyone else ever intended this rule to be a substitute for a detailed financial plan and a well-conceived retirement withdrawal strategy. I’m hopeful (and fairly certain) that no financial advisor worth his or her salt would ever rely on a percentage rule of thumb to plan a client’s retirement. Rather, a retirement withdrawal strategy needs to be carefully planned, monitored and at times adjusted to ensure success. Things change in the financial markets and in the circumstances of your clients.

Morningstar’s head of retirement research, David Blanchett, offered some remarks about the 4% rule at the Morningstar Conference in Chicago recently. His comments included:

• Bengen’s study didn’t look at the retiree’s ending balance; it only dealt with the ability to fund a retirement over a 30-year time period. Certainly in today’s world it would not be uncommon for a retirement to span a longer time period with 40 years not being out of the question.
• Bengen’s use of the 4% number pertained only to the initial balance—not 4% of each year’s beginning balance.
• He also indicated that Bengen’s research only took historical rates of return into account; there was no mention of future projected rates of return. (For more, see: Why Saving 10% Won't Get You Through Retirement.)

To this last point, Blanchett commented that using less rosy future expected returns resulted in a lower rate of success—around 50%—for a balanced portfolio. Further, he indicated that an all-bond portfolio would have only around a 3% chance of success.

Blanchett also made the point to the audience made up mostly of financial advisors that their clients are generally wealthier than the average person and hence tend to live longer.

A 2015 New York Times article reviewed some of the new thinking—outlined below—surrounding Bengen’s 4% rule and other theories around the appropriate withdrawal rate for retirees. It looked at a hypothetical couple, both aged 65, with a $1 million portfolio consisting of an asset allocation of 50% stocks and 50% bonds. It further assumed that the couple’s spending would never dip below $15,000 annually on an inflation-adjusted basis.

Constant inflation adjusted spending. This entails retirees withdrawing a given percentage of their initial retirement portfolio and then increasing the amount to account for inflation. Under this scenario, the withdrawal amount was maintained at a constant $28,500. The initial withdrawal rate was 2.85%. In the best case, their portfolio ended with a balance of just under $2.7 million; the average ending balance was $795,000; in the worst case, the portfolio had an ending value of $17,900 after 30 years of retirement.

Bengen’s floor and ceiling rule. This is refinement of Bengen's original 4% rule. Here the retirees start with a given percentage withdrawal from their nest egg. Beyond that, the percentage could increase by as much as 25% in a bull market for stocks, but wouldn’t decrease by more than 10% in a bear market. Under this scenario, the annual withdrawals ranged from 28,000 to $39,500. The initial withdrawal rate was 3.29%. In the best case with this scenario, their portfolio ended with a balance of just under $2.15 million; the average ending balance was $709,000; in the worst case, the portfolio had an ending value of $17,100 after 30 years of retirement.

Guyton’s and Klinger’s decision rules. Jonathan Guyton, a financial advisor, and David Klinger devised a withdrawal methodology where withdrawals are increased each year to match inflation except in those years where the portfolio loses money. If the withdrawal rate ever increases to 120% of the initial rate, then the withdrawal for that year is cut by 10%. In good years the withdrawal rate may increase by 10%. The initial withdrawal rate was 4.95%. (For related reading, see: Can I Retire Yet?)

Under this scenario, in the best case, their portfolio ended with a balance of just over $1.14 million; the average ending balance was $345,000; in the worst case, the portfolio had an ending value of $43,900 after 30 years of retirement. This scenario had the widest range of annual withdrawals, which, over the 30-year period, was $15,800 to $61,000.

All of these approaches — and a number of others—have merit. These were all created by smart people with solid industry backgrounds. The 4% rule and many others may be good starting points in conversations with clients regarding how much of their nest egg they will be able to withdraw during retirement. For example, a client with a $1 million nest egg could conceivably withdraw $40,000 each year. From there, financial advisors should also take other sources of retirement income into account — like Social Security or a pension—to give the client a ballpark idea of where they stand in terms of their retirement income.

Ideally as your client’s financial advisor, you will be working with them to manage their retirement withdrawals both initially and ongoing. This should entail a withdrawal plan that needs to be reviewed and, if needed, revised on a regular basis. Things could change in terms of the performance of their investments as well as the client’s situation. (For related reading, see: The Downside of Spending Retirement Savings.)

Retired financial advisor Bill Bengen's 4% rule for retirement withdrawals has been a staple of the financial planning world for over 20 years. It remains, along with several other withdrawal strategies, a solid starting point for determining the level of withdraws that a retiree’s portfolio can support. However, no rule of thumb or approach is one size fits all. Financial advisors need to work with their clients to put a withdrawal strategy in place, monitor their client’s progress and adjust that strategy when warranted. (For related reading, see: Here Is Your Retirement Checklist.)