There are many rules of thumb and retirement planning strategies that people rely on, but few have stood the test of time like the 4% Rule.
The 4% Rule originated from research published by financial advisor William Bengen in 1994. Bengen wanted to provide clients with evidence-based guidance on how much they could safely withdraw from their retirement portfolios each year without running out of money.
To develop his findings, he studied some of the worst market environments in modern history, including the Great Depression (1929–1931), the recession of 1937–1941, and the stagflation period of 1973–1974. His analysis considered not only market declines but also inflation, since rising prices can significantly impact a retiree's purchasing power.
Interestingly, Bengen found that the most challenging retirement environment was not the Great Depression, but the period from 1973 to 1974, which he referred to as the "Big Bang." During this time, portfolios were hit by a combination of steep market losses and rapidly rising inflation. While portfolio values declined by more than 35%, inflation surged by over 22% during the period. The combination of declining assets and rising living costs created a particularly difficult environment for retirees.
After analyzing these and other historical periods, Bengen concluded that retirees could safely withdraw 4% of their portfolio value in their first year of retirement and then increase that withdrawal amount each year to keep pace with inflation. Even in the worst historical scenarios he tested, this approach allowed a portfolio to last at least 30 years.
For example, a retiree with a $1,000,000 portfolio could withdraw $40,000 during the first year of retirement. In future years, that withdrawal amount would be adjusted for inflation continually increasing, regardless of portfolio performance.
It is important to note that Bengen's research assumed a diversified portfolio. His findings were based on portfolios holding between 50% and 75% in stocks, with the remainder invested in intermediate-term Treasury bonds. While portfolios with higher stock allocations often produced larger ending balances during favorable market conditions, portfolios with slightly lower stock allocations tended to perform better during the most challenging retirement periods.
So, what does this mean for retirees today?
The 4% Rule provides a useful benchmark for understanding retirement readiness. While no rule can guarantee future results, the research suggests that many retirees can reasonably expect to withdraw approximately 4% of their initial portfolio value, adjusted annually for inflation, throughout a retirement lasting 30 years or more.
However, retirement planning is rarely as simple as applying a single rule. Factors such as taxes, Social Security timing, pension income, spending patterns, market valuations, and healthcare costs can all influence the amount a retiree can safely withdraw. Financial planning software can be a valuable tool, but understanding the assumptions behind the projections is just as important as the projections themselves.
It is also worth noting that Bengen later updated his research and suggested that certain well-diversified portfolios may support withdrawal rates higher than 4% under some circumstances.
Like most aspects of financial planning, the answer depends on your specific situation. The 4% Rule is an excellent starting point, but a personalized retirement income strategy is often the best way to ensure your assets support the lifestyle you want throughout retirement.
If you have questions about your own retirement plan, feel free to leave a comment or contact our office.
Bibliography:
Bengen, William P. “Determining Withdrawal Rates Using Historical Data”, Oct 1994.
Canole, James CFP®, Bengen, William P. “You Could Spend WAY More Than the 4% Rule Suggests (Says the Man Who Created It” https://www.youtube.com/watch?v=vs2ymaBPZCI