What Is The 4 Percent Rule?


With most people relying almost exclusively on their own assets to generate lifetime income sufficiency, it’s up to each individual to determine the optimal rate at which they can safely spend down their assets so they don’t outlive them. Several decades ago, a financial advisor came up with the “4 percent rule,” which has been widely adopted by many financial planners as a starting point for determining how much can be withdrawn annually from your accounts over your lifetime.

Essentially the rule states that you should be able to withdraw 4 percent of your assets each year without the risk of depleting them too soon. However, that rule was developed over 40 years ago based on an asset allocation of 50 percent stocks and 50 percent bonds. It was determined that would be a safe rate of withdrawal during any 30-year period between 1926 and 1976.

Is the 4 Percent Rule Still Valid? 

While that rule may have worked well in the 1980s and 1990s due to surging stock prices, it didn’t work so well in the 2000s, which saw a stagnate stock market and declining housing prices. Retirees found themselves having to increase the percentage and accelerate the depletion of their assets to cover their living expenses. More recently, in the 2010s and 2020s, bond yields have declined, generating far less income than in previous decades. The only remedy retirees had was to reduce their withdrawals or lifestyle or risk depleting their assets too soon.

Today’s retirees are discovering that rules based on decades-old averages and assumptions don’t account for 21st-century realities. Rising healthcare costs and longer life expectancies were not factored into the rule back then. Some financial advisors have tried to adjust for this by changing the 4 percent rule to the 3 percent rule.

From the start, the 4 percent rule was to be used as a rule of thumb, a planning guide, not as a final strategy. Given the enormous complexities around determining an optimal spend-down strategy, it can leave retirees in the uncertain position of adjusting their spending in reaction to the performance of their assets. Short of a real income distribution strategy, determining how much to withdraw each year becomes a dangerous crapshoot.

Retirement Income Planning Requires More Than Rules of Thumb

Determining a safe spend-down rate should be done in concert with an overall retirement income plan factoring in a retiree’s income needs, retirement asset mix, expected returns, tax situation, inflation, and the uncertainty of the markets. The plan needs to be monitored regularly so timely adjustments can be made to maintain the balance between income needs and the rate of asset depletion.

As far as retirement planning goes, the accumulation phase is far less complex than the distribution phase to ensure you can comfortably meet your lifestyle goals. Planning for lifetime income sufficiency should be done with the guidance of a qualified advisor who specializes in retirement income planning.