What is the 4% Rule For retirement?
The 4% rule is a retirement withdrawal strategy that’s been used and recommended by many investors since the 1990s. Developed in 1994 by financial advisor William Bengen, this guideline suggests withdrawing 4% of your retirement savings in the first year, then adjusting that amount for inflation each year to help ensure your funds last at least 30 years.
Who is the 4% Rule For?
The 4% rule could be a good fit if you're planning to retire at 65 or later and don’t mind a little risk. The risk comes in because it’s tied to market performance, so your results might fluctuate with inflation and investment returns. If that sounds like it could work for you, it’s worth considering.
If you’re not a fan of risk, the 4% rule might not be the best option since it usually assumes you have a decent amount of your savings invested. It’s also not ideal if you're thinking about retiring early. If you're planning for a long retirement, taking out 4% each year could end up draining your savings faster than you'd like.
How Does the 4% Rule Work?
The 4% rule for retirement is pretty simple. You just withdraw 4% of your retirement savings in Year 1, then adjust future withdrawal amounts up or down with the rate of inflation.
Here’s how the math works with a $1,000,000 retirement account:
- Year 1: Withdraw $40,000 (4% of $1,000,000)
- Year 2: Withdraw $40,800 ($40,000 + 2% inflation rate)
- Year 3: Withdraw $41,616 ($40,800 + 2% inflation rate)
If you’ve been keeping track, you’ll see that the $1,000,000 would be gone by the 21st year. The 4% rule is effective because it assumes that about half of your retirement savings in accounts like 401(k)s and IRAs will grow each year along with the stock market. With that growth factored in, the rule is designed to make your money last around 30 years.
What happens if the stock market takes a hit? Or if inflation rises? The good news is that the 4% rule was designed as a safe estimate for tougher times, while a 5% withdrawal rate might be more reasonable in normal conditions.
