The 4% Rule Is Under Fire. Here's Why.

Key Points

The 4% rule has long been touted as a great strategy for managing a retirement nest egg.

It has you withdrawing 4% of your savings your first year of retirement and adjusting subsequent withdrawals for inflation.

The rule has many problems savers should know about.

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When you sacrifice to build retirement savings, you want that money to last. That's why it's important to manage withdrawals from your IRA or 401(k) carefully.

For decades, financial planners have leaned on a popular rule of thumb to manage a retirement nest egg-the 4% rule. The 4% rule has you withdrawing 4% of your savings your first year of retirement and adjusting subsequent withdrawals for inflation.

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For example, let's say you retire with a $1 million IRA. Using the 4% rule, you'd withdraw $40,000 your first year of retirement. You'd then increase your withdrawals as needed to keep pace with rising living costs. If you follow that guidance, there's a good chance your nest egg will last for 30 years.

On paper, the 4% rule sounds like a good plan. In practice, it may not be.

Lower returns could change the math

One of the biggest challenges to the 4% rule is a shifting interest rate environment. Today's bond yields, as well as future ones, may not be enough to support a 4% withdrawal rate on an ongoing basis.

Also, the 4% rule assumes a fairly even mix of stocks and bonds within a retirement portfolio. An overly conservative asset mix could lead to lower returns that don't support a 4% withdrawal rate.

A stock-heavy portfolio, on the other hand, might allow for larger withdrawals, which could lend to a better quality of life in retirement. By only withdrawing 4%, you might limit yourself.

Sequence of returns risk could break the rule early

Another issue with the 4% rule has to do with sequence of returns risk. If the market slumps early on in retirement when withdrawals are just beginning, sticking to a 4% rate could put your portfolio at risk of running out early.

Of course, this risk doesn't exist at the start of retirement only. It's an ongoing risk. But any time you sell assets at a loss to generate income in retirement, you make it harder for your portfolio to recover. When that happens early on, your risk of depleting your savings increases.

Spending doesn't always stay flat

The 4% rule assumes your expenses will stay the same from year to year, aside from inflation. But your spending patterns may be very different early on in retirement than later.

Let's say you retire at 65. You may decide to spend the next five years doing heavy travel while your health is strong. But your spending might shrink substantially in your 70s as you decide to slow down.

If you follow the 4% rule, you may be locked into a lower withdrawal rate early on in retirement when you can afford to take larger distributions knowing they'll drop later on. That could mean missing out on big experiences.

Longevity is a risk factor, too

The 4% rule was designed around a 30-year timeframe. But people are generally living longer these days. When you combine that with early retirement, the 4% rule becomes riskier.

You may want to take a more flexible approach

All told, the 4% rule is not a bad starting point for managing your retirement account. But rather than lock yourself into a single rule, a better bet may be to take a more flexible approach to managing your nest egg.

That could mean adjusting spending upward during the early stages of retirement to maximize good health. It could also mean increasing spending when the market does well and reducing spending during periods of market turbulence.

Also, take your various income streams into account. If you have Social Security, a pension, and income from a part-time job, you may not need to tap your portfolio to the tune of 4% every year.

All told, the 4% rule is easy to understand and provides a helpful starting point for managing a retirement nest egg. But it may not be right for everyone. And it may not be optimal for you.

One thing you may want to do is treat the 4% rule as a starting point for managing your savings. From there, make tweaks based on your changing needs and market conditions.

Your actual ideal withdrawal rate may be 4% some of the time, but not all of the time. And it's OK to have a strategy that allows for that.

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