Does the 4% Rule Still Stand?

Since its creation more than three decades ago, the 4% rule has been cited as a simple guide for retirement withdrawals. The approach to finding a “safe” initial withdrawal rate involves pulling 4% of your retirement savings in your first year of retirement, then continuing to do so each subsequent year while adjusting for inflation.

When the 4% rule was published by Bill Bengen in 1994, it was groundbreaking, says David Blanchett, head of retirement research for PGIM DC Solutions. It remains a novel piece of research in the retirement industry.

“It was and is still relevant today,” Blanchett adds.

But given the rule’s age, it is important to ask how some of its key assumptions can be improved upon to make it more relevant. In today’s economic climate, retirees are facing market volatility, inflation and increasing longevity—and industry experts are rethinking traditional drawdown strategies.

The State of the 4% Rule

In past years, when interest rates were so low, Wade Pfau, author of the “Retirement Planning Guidebook” and a professor of practice at the American College of Financial Services, says he was concerned about the viability of the 4% rule. But he now feels more comfortable with its ability for success.

“Today, with interest rates being higher, if you wanted 30 years of inflation-adjusted spending, you could build a 30-year TIPS ladder,” he says, referring to Treasury inflation-protected securities. “Right now, with interest rates, that would support about a 4.6% withdrawal rate.”

But interest rates fluctuate, and if they do drop, the sustainable withdrawal rate could fluctuate every day. In short, the 4% rule is a “research simplification,” Pfau explains. It does not take into account variations in cash flow—including whether Social Security has kicked in for a retiree yet—or taxes, which do not grow with inflation. The rule also maximizes sequence-of-returns risk because retirees never adjust spending in relation to how their portfolios are performing.

Those who implement the rule also need to account for its assumptions, including that it is specifically designed for a 30-year retirement.

“The 4% rule is a reasonable starting point,” says Amy Arnott, a portfolio strategist for Morningstar. But, she says, it won’t make sense for everyone.

Flexible Spending Methods

When Morningstar published its most recent “State of Retirement Income” report, the firm recommended people be slightly more conservative: a 3.7% withdrawal rate for those who want to follow a steady-state approach, withdrawing the same amount each year and adjusting it for inflation.

But Arnott says there are other approaches retirees can take that boost that figure. She and the other authors behind Morningstar’s report looked at four different flexible spending methods. They estimated that on one end, the safest withdrawal rates for the basic approach, in which anytime the portfolio value is down, a retiree skips the inflation adjustment the following year, was 4.2%. On the other end was the guardrails approach, where retirees compare the estimated withdrawal rate with the portfolio balance each year and make adjustments if that portfolio performs outside a certain level, with a safe withdrawal rate of 5.1%.

When it comes to deciding which withdrawal method makes sense, Arnott says retirees should consider what is important to them: Is it having a consistent level of income or maximizing the amount they can take out, especially early in retirement? Do they really want to leave a legacy behind for family members or charity, and are they comfortable with variations in cash flows from year to year?

“Another thing to think about is how much uncertainty you’re willing to live with,” she says, adding that Morningstar is “very conservative” in its estimates and uses a 90% probability of success that some savers may be willing to bump down. She also recommends considering guaranteed income, including Social Security income or a pension or the possibility of purchasing an annuity to support part of retirement spending.

Guided Spending Rates

Blanchett says PGIM uses an approach in line with the research behind the 4% rule, but based on a different model: guided spending rates. The approach uses forward-looking returns (instead of historical returns, which the 4% rule uses) and allows for savers to take into account their perceived level of flexibility. The spending rates have three levels—conservative, moderate and enhanced—that tend to be approximately 4.0%, 5.0% and 5.5%, respectively, according to PGIM’s 2024 report on guided spending rates.

The research supporting the 4% rule—and many financial planning tools—determines the “safe” withdrawal rates by focusing on whether the retiree’s goal is accomplished in its entirety, which does not leave room for considering the total amount of the goal accomplished and potential implications if there is a shortfall, according to the report.

“The problem with that is: What if you want to have $100,000 a year in retirement for 30 years, and then in the 30th year, you fall $10 short? That would be considered a failure in that kind of model, but it’s not a failure; you’ve accomplished all of your goals,” Blanchett says. “So we’re thinking about outcomes, more than just success rates.”

Most American retirees have lifetime income to cover most of their essentials, which means the implication of making a change are not as dire as analyses that use success rates and treat a $1 shortfall as failure, Blanchett says.

“You don’t want to go broke when you’re alive, but you also don’t want to get to the age of 80 and think, ‘Gosh, I could have done all these cruises and really cool stuff when I was a younger retiree,” he adds.

More Alternative Approaches

The 4% rule is an appropriate starting point for somebody more comfortable relying on portfolio growth and market growth to fund retirement expenses, Pfau explains. But starting there dismisses the bucketing approach, which involves allocating money to three separate buckets, each of which corresponds to a different time period in retirement, as well as income-protection approaches.  

“A lot of people will be more comfortable having more protections built in,” Pfau says. “The 4% rule really is just taking the pre-retirement investment management and just applying that post-retirement as well.”

More on this topic:

What to Know About Adding Income to a Plan Lineup