More Good News: The 4% Rule Is Back

| March 01, 2024

Approaching retirement, everyone wants to know how they can maintain their lifestyles after they stop working. How do they decide when to start taking money from their retirement accounts and how much they should take?

In the mid-1990s, financial advisor Bill Bengen came up with a general answer. He used historical data on stock and bond returns over the 50-year period from 1926-1976 to determine that an initial 4% annual withdrawal rate from a retirement portfolio, followed by subsequent adjustments upward to roughly match inflation, never exhausted its funds in fewer than 33 years. That’s an important insight that gives guidance on when many people can retire and how they should budget their withdrawals from retirement portfolios. Subsequently, “the 4% Rule,” also known as “Bengen’s Rule,” came to be a guideline used by many financial planners and retirees to estimate a safe, initial rate of withdrawal for one’s retirement nest egg.[i]

That common wisdom held until 2021, when Morningstar created a forward-looking study, generating 1,000 simulations of future market conditions to determine an initial “safe” withdrawal amount that would allow for a steady annual income for 30 years. They found that an initial withdrawal rate of 3.3%, followed by adjustments for inflation, would have a 90% rate of success lasting 30 years. They ran the simulations again in 2022 and found that the initial rate could be raised to 3.8%.

Thanks to lowered inflation, higher interest rates, and higher bond yields in 2023, Morningstar’s latest simulations pushed the initial rate back up to 4.0%.[ii] Of course, there is no guarantee that a 4% withdrawal rate will make a retirement portfolio last 30 years. It would depend on the mix of equities, bonds, and other holdings in the account. The algorithm is ultimately based on past performance of markets, which don’t necessarily predict the future.

But the model is also conservative, based on worst-case scenarios developing in the 30-year period. Bengen thinks that 5% is a more realistic number.[iii] Indeed, 4% is modest relative to the long-term historical average return of almost 8%

on a balanced (60% equity/40% credit) portfolio.[iv]

Most importantly, the 4% Rule is a “rule of thumb.” People should make specific plans with a financial planner, and consider things like age of retirement, life expectancy, allocations within a portfolio, other forms of income, such as Social Security, and special needs people have. A planner can also help design a more complex, dynamic withdrawal schedule with flexible withdrawal systems or a bond ladder for extra security. Withdrawal schedules are about finding a balance between enjoying the benefit of one’s hard-earned savings balanced against the risk of running out of money. It’s wise to get professional advice in making specific plans.