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Safe Withdrawal Rates for Retirement – Does the 4% Rule Still Apply?

How much do you need to retire? How much money can you pull out of your nest egg every year in retirement without worrying that you’ll run dry? At the core of both questions is the concept of safe withdrawal rates.

It’s hard to have a happy and comfortable retirement if you run out of money. To make sure your money doesn’t shuffle off this mortal coil before you do, here’s the lesson you never learned in school about how to plan your retirement savings and spending.

What Is a Safe Withdrawal Rate?

If you’re not familiar with the term “safe withdrawal rate,” don’t worry. Most Americans have no idea how much they need for retirement, much less whether they’re on track to reach that goal.

A safe withdrawal rate is simply an attempt to answer the question “What percentage of your retirement savings can you sell off every year, without worrying that you’ll run out of money before you die?” For example, if you have $1 million when you retire, how much can you safely withdraw every year to live on?

While the answer depends on your goals and risk tolerance, it’s not as complicated as you might suspect.

The 4% Rule

In 1994, a financial advisor named William Bengen reviewed decades of historical market data to determine the maximum safe withdrawal rate. His findings, first published in an article titled “Determining Withdrawal Rates Using Historical Data,” revolutionized retirement planning.

Bengen analyzed 50 years of data on how a retirement portfolio made up of 60% equities (tracking the S&P 500 index) and 40% bonds (in this case, intermediate-term U.S. government bonds) performed. Even for the worst-performing 30-year scenarios, he found that retirees could withdraw 4.15% of their nest egg annually without running out of money in 30 years. “The 4.15% rule” doesn’t have quite the same ring to it, so the figure was rounded down to “the 4% rule” in subsequent discussions.

For example, a person with $1 million could withdraw $40,000, or 4%, of their nest egg in their first year of retirement without having to worry that they’ll run out of money in the next 30 years.

What About Inflation?

Bengen’s study adjusted for inflation, so the 4% rule is just a guideline for the first year of retirement. At a 2% inflation rate, a retiree with a $1 million nest egg would withdraw $40,000 in their first year of retirement, $40,800 in their second year, and so on. That way, their purchasing power remains the same over time.

This differs from Social Security benefits, at least in terms of real dollars. While Social Security alleges to make cost-of-living adjustments every year, a study by The Senior Citizens League demonstrated that the real purchasing power of Social Security benefits dropped 30% between 2000 and 2017.

Using the 4% Rule to Set a Target Nest Egg

You can also use the 4% rule to set a target for how much you need to retire. If you plan on withdrawing 4% of your portfolio in a year, then you need to save up 25 times your annual spending as a nest egg. This corollary is known as the 25x rule.

For example, if you need $40,000 per year to live on, then you should save $1 million. You simply reverse the formula: 4% x 25 = 100%. It’s a quick shorthand that you can do on the back of a napkin to estimate roughly how much you need to retire.

Does the 4% Rule Hold Up in Today’s Economy?

As with everything else under the sun, not all economists agree with the 4% rule. One objection some cite is the lower yield on bonds today than in the 1990s when Bengen performed his analysis.

Supporters of the 4% rule reply that retirees can always leave more of their portfolio in equities to generate better average returns. However, that leaves them more vulnerable to sequence risk, or the risk of a market crash within the first few years of retiring, which can decimate your nest egg.

Other economists forecast lower stock returns over the next decade. They argue that just because a 4% withdrawal rate was safe for the last hundred years, that doesn’t mean it will be safe in the future.

Ultimately, the debate boils down to a single question: Are you willing to base your retirement planning on historical data? If you aren’t, then retirement planning slips into the realm of speculation and forecasting. You’ve read the disclaimer a hundred times: “Past performance is not necessarily indicative of future results.”

But if history can’t inform us, then what can?

Updates on Historical Data

Critics of the 4% rule have a point; Bengen’s original research is nearly 25 years old. Has anything changed in the intervening years?

Financial planner Michael Kitces has researched the 4% rule extensively. Analyzing data going back to the 1800s, Kitces demonstrates that a 4% withdrawal rate with Bengen’s 60% stocks and 40% bonds allocation would never have resulted in a nest egg running out of money in less than 30 years — not even in the worst 30-year periods.

He doesn’t stop there. In most historical scenarios, retirees would actually have more money in their accounts after 30 years, not less. Even with a 4.5% withdrawal rate, Kitces shows that in 96% of the 30-year periods since 1926, retirees would have larger nest eggs after 30 years than when they first retired.

Therein lies one of the problems with retirement planning. Retirees have to plan for the worst-case scenario, even though it will mean spending far less than they may need to live.

Or do they?

Retirement Plan Glasses Graph Binder

How Long Do You Plan to Live After Retiring?

Wade Pfau, a professor of retirement planning at The American College, offers another way of looking at the data. Reviewing similar data since 1926, Pfau analyzed the likelihood that a nest egg will last for 15, 20, 25, 30, 35, or 40 years based on different withdrawal rates. He used this approach for different asset allocations, shifting the balance between stocks and bonds.

Portfolios made up primarily of bonds fared poorer, but portfolios comprising at least 50% equities performed well.

At 75% stocks and 25% bonds, Pfau found that portfolios had a 98% chance of surviving for 30 years by following a 4% withdrawal rate. He also found a 93% chance of surviving for 35 years and a 92% chance of surviving for 40 years.

What if you withdraw more every year — say, at a 5% withdrawal rate? Your portfolio will only have a 78% chance of surviving 30 years, a 69% chance of surviving 35 years, and a 66% chance of surviving 40 years.

But not everyone plans on living for 30 to 40 years after retiring. If you only plan on living for 15 years after retiring, a 5% withdrawal rate has a 100% history of success. Even a 6% withdrawal rate has a 97% chance of lasting at least 15 years.

Pfau’s numbers for a portfolio split 50/50 between stocks and bonds put up similar results. At a 4% withdrawal rate, 100% of these portfolios lasted 30 years, 97% lasted 35 years, and 87% lasted 40 years. A portfolio with a 5% withdrawal rate lasted at least 15 years in every single 30-year period and 99% of 20-year periods.

The Never-Ending Nest Egg

In Pfau’s numbers, a 3% withdrawal rate left nest eggs intact over every single 40-year period going back to 1926 for portfolios based on 50/50 or 75/25 splits in stocks and bonds. But what if you want to retire extremely young and plan on living for another 45, 50, or even 60 years?

It turns out that if a portfolio can survive the first 10 to 15 years with minimal losses, it’s likely to continue growing forever. Kitces demonstrates that a 3.5% rate effectively forms a safe withdrawal rate “floor.” If a retiree can withdraw no more than 3.5% each year for the first 15 years, they overcome the initial sequence risk, and their portfolio keeps growing indefinitely. A withdrawal rate of around 3.5% is safe for the first 40 to 45 years, and portfolios that can last that long are almost certain to reach “escape velocity” and continue growing.

Let’s consider two scenarios. Say you start with a nest egg of $1 million in 1968. In one scenario, you want it to last at least 30 years, so your initial withdrawal rate is 4%. In the other scenario, you want to live for 50 years after retiring, so your initial withdrawal rate is 3.5%. Each year, you take a cost-of-living increase of 2% to account for inflation.

Below are actual returns from the S&P 500. For simplicity, we’re dispensing with the stock/bond allocation split and just using stock returns.

YearReturn4% Withdrawal RatePortfolio Value3.5% Withdrawal RatePortfolio Value
19687.66%$40,000.00$1,036,600.00$35,000.00$1,041,600.00
1969-11.36%$40,800.00$878,042.24$35,700.00$887,574.24
19700.1%$41,616.00$837,304.28$36,414.00$852,047.81
197110.79%$42,448.32$885,201.09$37,142.28$906,841.49
197215.63%$43,297.29$980,260.74$37,885.13$1,010,695.69
1973-17.37%$44,163.23$765,826.22$38,642.83$796,495.02
1974-29.72%$45,046.50$493,176.17$39,415.68$520,361.02
197531.55%$45,947.43$602,825.82$40,204.00$644,330.92
197619.15%$46,866.38$671,400.59$41,008.08$726,712.21
1977-11.5%$47,803.70$546,385.82$41,828.24$601,312.07
19781.06%$48,759.78$503,417.73$42,664.80$565,021.17
197912.31%$49,734.97$515,653.49$43,518.10$591,057.18
198025.77%$50,729.67$597,807.72$44,388.46$698,984.15
1981-9.73%$51,744.27$487,896.76$45,276.23$585,696.76
198214.76%$52,779.15$507,131.17$46,181.76$625,963.84
198317.27%$53,834.73$540,877.99$47,105.39$686,962.41
19841.4%$54,911.43$493,538.86$48,047.50$648,532.38
198526.33%$56,009.66$567,477.98$49,008.45$770,282.51
198614.62%$57,129.85$593,313.41$49,988.62$832,909.19
19872.03%$58,272.45$547,085.22$50,988.39$798,828.86
198812.4%$59,437.90$555,485.90$52,008.16$845,875.48
198927.25%$60,626.65$646,229.15$53,048.32$1,023,328.22
1990-6.56%$61,839.19$541,997.33$54,109.29$902,088.60
199126.31%$63,075.97$621,520.86$55,191.47$1,084,236.64
19924.46%$64,337.49$584,903.20$56,295.30$1,076,298.29
19937.06%$65,624.24$560,573.12$57,421.21$1,094,863.74
1994-1.54%$66,936.72$485,003.57$58,569.63$1,019,433.21
199534.11%$68,275.46$582,162.83$59,741.03$1,307,420.85
199620.26%$69,640.97$630,468.06$60,935.85$1,511,368.46
199731.01%$71,033.79$754,942.41$62,154.56$1,917,889.26
199826.67%$72,454.46$883,831.09$63,397.66$2,365,992.67
199919.53%$73,903.55$982,539.75$64,665.61$2,763,405.43
2000-10.14%$75,381.62$807,528.60$65,958.92$2,417,237.20
2001-13.04%$76,889.26$625,337.61$67,278.10$2,034,751.37
2002-23.37%$78,427.04$400,769.17$68,623.66$1,490,606.31
200326.38%$79,995.58$426,496.49$69,996.13$1,813,832.12
20048.99%$81,595.49$383,243.04$71,396.06$1,905,499.58
20053%$83,227.40$311,512.92$72,823.98$1,889,840.58
200613.62%$84,891.95$269,049.03$74,280.46$2,072,956.41
20073.53%$86,589.79$191,956.67$75,766.07$2,070,365.71
2008-38.49%$88,321.59$29,750.96$77,281.39$1,196,200.56
200923.45%$90,088.02($53,360.46)$78,827.02$1,397,882.57
201012.78%$80,403.56$1,496,128.41
20110%$82,011.63$1,414,116.78
201213.41%$83,651.86$1,520,097.98
201329.6%$85,324.90$1,884,722.09
201411.39%$87,031.40$2,012,360.54
2015-0.73%$88,772.02$1,908,898.29
20169.54%$90,547.46$2,000,459.72
201719.42%$92,358.41$2,296,590.58

 

In the 4% withdrawal rate scenario, the nest egg lasted over 40 years, finally expiring in 2009. But at a 3.5% withdrawal rate, the nest egg lasted indefinitely, clocking in at $2,296,590.58 after 50 years. There’s no reason to believe the nest egg won’t still be going strong 50 years after that.

Why did the portfolio last forever at a 3.5% withdrawal rate but run out after 40 years at a 4% withdrawal rate? Because the less money you take out, the more is left in the portfolio to capitalize on market upswings, even after the downswings.

Elderly Couple Financial Planner Meeting

Practical Takeaways for Aspiring Retirees

Numbers and data are all well and good, but what does this mean for you and your retirement planning?

1. How Long You Live Affects Your Safe Withdrawal Rate

Figuring out when you want to retire, and how long you plan to live after retiring, involves estimation. You may live to reach 115. But your estimate impacts your decision about when to retire and has an enormous impact on how much you can withdraw every year.

If you only plan to live for 15 years after retiring, you can withdraw 6% of your nest egg every year with confidence that your portfolio will last at least 15 years. If you plan to live for another 50 years after retiring, then rein in that spending to 3.5% of your nest egg.

2. The Younger You Retire, the More Flexible You Should Be

In the first decade or so of retirement, you face the danger of sequence risk, or the risk of a stock market crash that can cripple your portfolio if you withdraw too much while stock values are low.

If the stock market crashes, how flexible is your spending? Can you cut costs to avoid selling off any stocks?

Market volatility is one factor that affects when you retire. If you can drop your spending when the stock market drops, you’ll be better positioned to withstand early losses and see your nest egg survive indefinitely.

3. Withdraw Less in the Early Years

Even if the stock market doesn’t crash within the first few years of your retirement, the less of your nest egg you eat into, the more likely it is to last.

One option is to continue working after retirement. There’s no reason why you can’t work part-time, or even full-time, doing something fun or rewarding after you retire. I plan to pour wines at a winery after I retire. I also plan to keep writing forever. My mother tutors children. My friends Kevin and Ashley Thompson still buy rental properties, despite retiring at 29.

Speaking of rental income, what kinds of investments can you buy that generate ongoing passive income and don’t require you to sell off assets? Brainstorm low-risk investments as you near retirement for sources of passive income. Bonds are the classic option, but you can also invest in high-yield dividend-paying stocks, funds, and real estate investment trusts (REITs). You can also look to private notes, crowdfunding websites, peer-to-peer lending websites, private equity funds, royalties, or business income.

Final Word

For many Americans, retirement planning is so intimidating that they avoid thinking about it entirely. That’s a recipe for poverty in retirement.

Start with the simple question “How much annual income could I live on after retiring?” Multiply that number by 25 for a rough estimate of your target nest egg. Depending on when you retire, you may have Social Security to help you. Find ways to maximize your Social Security benefits to minimize the nest egg you’ll need. Also, remember that a shorter retirement means a higher safe withdrawal rate. If you only plan to live 15 to 20 years after retiring, you can withdraw 5% to 6% each year rather than 3.5% to 4%.

Retirement planning doesn’t have to be complicated. Avoid these retirement planning mistakes, capitalize on IRAs and other tax-free retirement accounts, and you may just find that a 30-, 40-, or even 50-year retirement is well within your grasp.

When do you plan to retire? Are you on track to reach your target nest egg?

G. Brian Davis
G. Brian Davis is a real estate investor, personal finance writer, and travel addict mildly obsessed with FIRE. He spends nine months of the year in Abu Dhabi, and splits the rest of the year between his hometown of Baltimore and traveling the world.

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