The 4% Rule: Determining How Much You Can Spend in Retirement

Individuals and couples often struggle to be confident about determining how much they can spend in retirement. We find that the accumulation phase, when you are simply buying into the market during your working years, is usually the easier part versus the later phase when you must decide how much to withdraw from savings in retirement. The mental hurdle of spending down your account balance can cause some anxiety. A sound financial plan with some guardrails, though, makes it not only easier on the retiree, but the right strategy also instills confidence and peace of mind. 

What is the 4% Rule?

Enter the 4% rule. You might have heard of this. It is a rule of thumb that helps many folks plan for retirement spending. The rule simply says that you can withdraw and spend 4% of your portfolio’s funds at the onset of retirement, then withdraw that amount, adjusted for inflation, every year thereafter. For example, if you retire at age 65 with $1 million, then on day one of retirement, you can pull $40,000 from your portfolio (4% of $1 million). If you require higher income to fund your yearly expenditures, then you would need a bigger portfolio balance.

Why Your Withdrawal Rate Matters

The goal is for your financial assets to provide a steady income stream throughout your retirement while still maintaining an adequate balance over time. In essence, what you are withdrawing annually is simply dividends and interest even though the total balance will naturally fluctuate (and rise over time) with markets. It’s important to recognize that the 4% rule is meant to be a rough estimate. It is not a replacement for a full financial plan. Determining your true “safe withdrawal rate” can only be accomplished by a careful assessment of your goals and risk & return objectives. 

The Research Behind this Retirement Rule of Thumb 

A detailed analysis of the 4% rule was conducted by a financial advisor/researcher in the mid-1990s who used a 50-year period of market returns from 1926 to 1976. The data showed that even during tough years of market declines, no period resulted in a depleted portfolio in fewer than 33 years. While some argue the 4% rule might be too aggressive today, other retirement experts suggest a higher annual withdrawal amount near 5% can be allowed. Among the many variables that go into determining your safe withdrawal rate is your life expectancy. Your assets must be able to last through your lifetime. 

Flexible Spending Helps Ensure a Successful Retirement

The 4% rule should also be a dynamic and flexible estimate. Individuals and couples will undoubtedly have years where they can withdraw more while other years might require smaller withdrawal rates. Moreover, a period of strong market returns commonly allows retirees to spend a bit more lavishly, but bear markets might result in temporary smaller annual withdrawals. 

Say Cheese! The Retirement Spending “Smile”

We find that many of our clients desire to spend more during the early portion of their retirement when they are actively upsizing, downsizing, or remodeling their homes. Other common expenses at the start of retirement include fun travel excursions and visiting family. Those are the so-called “go-go” years when clients have the time, energy, and money to live life to the fullest. (Which is great to see!) 

Spending often drops during mid-retirement, perhaps in one’s 70s and early 80s, then begins to increase toward the end due to high medical costs. Our financial plans generally assume this “smile” pattern of spending – high early, lower in the middle, then rising at the end of retirement.

What Matters Most to You?

What’s also important about the 4% rule is that it should vary based on your legacy goals. If you wish to leave more money to multiple beneficiaries, maybe kids, grandchildren, or charities, then we assume a higher account balance at the end of retirement when building a spending plan. If a client has no specific desire to leave funds to a person or charity, then the plan can allow for a little more aggressive spending throughout retirement.

Do you have a plan for how you will fund your life in retirement?

The 4% rule helps people get a ballpark figure of how much they can pull from their accounts each year, but more planning is often needed to account for unique risks, goals, and situations. 

Here’s something you can do: Tally up your financial assets and what you think you will have when you wish to retire. Is 4% of your financial assets enough to fund your lifestyle? Or do you have some work to do to get there?

If you think you might struggle with life after work, read this next: 7 Tips to a Happy Retirement Transition