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The 4% Rule Explained (and Where It Falls Short)
The 4% rule is one of the most quoted ideas in retirement planning. It is simple, which is why people like it, but it is a rule of thumb built on assumptions. Knowing those assumptions helps you use it wisely.
What the rule says
In the first year of retirement, you withdraw 4% of your portfolio. In every later year, you withdraw the same dollar amount adjusted for inflation. For example, with $1,000,000 you would withdraw $40,000 in year one, which is about $3,333 a month. If prices rise 3% the next year, you would withdraw $41,200.
Where it comes from
The idea comes from research in the 1990s by financial planner William Bengen and a later study known as the Trinity study. They tested historical U.S. market returns and asked how much a retiree could withdraw without running out over about 30 years. Withdrawing around 4% in the first year, with inflation increases, would have survived in most of the historical periods tested, including some very bad ones.
The rule of 25
Flip the 4% rule around and you get the "rule of 25": to withdraw $40,000 a year, you want about $1,000,000 saved (25 times $40,000). It is a fast way to turn a spending goal into a savings target.
Where the 4% rule can fall short
- Longer retirements. The research focused on about 30 years. If you retire in your early 50s, your money may need to last 40 years or more, and many planners suggest a lower starting rate such as 3% to 3.5%.
- Different markets. Results were based on past U.S. returns. The future may be different, with lower returns or higher inflation.
- Sequence of returns risk. Poor returns in the first few years of retirement hurt much more than poor returns later, because you are withdrawing money while prices are down.
- Taxes and fees. The rule does not account for taxes on withdrawals or investment fees, which both reduce what you can actually spend.
- Real spending is not constant. Most people do not raise their spending with inflation every single year. Spending often declines in later retirement, while healthcare costs can rise.
Ways to make the rule safer
- Stay flexible. Skipping an inflation increase or trimming spending after a bad market year can greatly improve how long your money lasts.
- Use guaranteed income. Social Security or a pension covers part of your spending, so you withdraw less from your portfolio.
- Keep a cash cushion. Holding one to two years of spending in cash or short-term bonds can help you avoid selling investments at a bad time.
- Review every year. Check your balance and spending annually and adjust gradually.
Use the free calculator to see whether you are on track.Open the retirement calculator
This article is for general educational purposes and is not financial, tax or legal advice. Rules and limits change; confirm details with official sources or a qualified professional. See our Disclaimer.