Does the 4% Rule Hold Up?

One of the biggest challenges of planning for retirement is figuring out how much you can spend. Retirement income planning requires careful preparation and budgeting.

A popular retirement income planning guideline is the 4% rule, which suggests that you live off 4% of your total investments during the first year of retirement. Then, you readjust every year in retirement based on your changing needs and inflation.

But does this rule hold up? Is the 4% rule a good strategy for you as you plan for living in retirement? Let's dive deeper into this rule and consider whether it's right for you.

What Is the 4% Rule?

The 4% rule is a guideline for managing your retirement income and suggests only withdrawing up to 4% of your savings each year of retirement. For example, if you have $1,000,000 saved for retirement, you will withdraw $40,000 the first year. In addition to the 4%, a retiree would have Social Security and possibly a pension.

The goal of the 4% rule was to devise a relatively easy concept to grasp, calculate, and hopefully ensure that a retiree does not outlive their assets.

In 1990, when the rule was established, the average American man was expected to live 15 years after age 65, and the average woman was just under 20 years. Using the 4% rule, retirees could expect to have about 35 years of living expenses. Today, life expectancies are longer, and it's common for a person to live into the 90s. 

So, the question remains: Does the famed 4% rule hold up today? Let's take a look.

Does the 4% Rule Hold Up Today?

The 4% rule has become an essential fixture in financial planning and, for the most part, has held up well to scrutiny. However, every retirement is different, so having one "rule" that works for everyone is impossible. While the 4% rule offers good insight into retirement income planning, it's more helpful to consider it a guideline than a rule.¹

Safety should be paramount when managing withdrawals and retirement income for those with fewer assets. Morningstar discusses "sequencing risk," the risk of encountering difficult market conditions early on in retirement when large withdrawals combined with market losses can pose a particular threat to portfolio balances and possibly threaten their longevity.

Your Investment Portfolio and Taxes

According to Prudential, the 4% rule assumes that "you have about 60% of your investments in equities and 40% in fixed income assets," and it's based on a tax-deferred portfolio like a traditional IRA or 401(k) and "assumes that you'll owe income tax on withdrawals." If you're spending from a Roth, where withdrawals aren't taxed, if you meet essential criteria, "your calculations may be different." ² The same would be true when withdrawing from a taxable account subject to capital gains taxes. 

Your Expenses

Everyone's expenses will look a little different in retirement, depending on where you live, how much money you have saved for retirement, your health care expenses, your hobbies, and whether you work part-time.

Your Healthcare Expenses

Unsurprisingly, healthcare costs have increased since the 4% rule was established in the 1990s. Today, the average 65-year-old couple can expect to spend over $300,000 on doctor's appointments and medical bills in retirement. Healthcare expenses are a significant part of your retirement income planning.³

Your Life Expectancy

In addition to increasing healthcare expenses, today's retirees live longer than they did 30 years ago. The average life expectancy in 1990 was 75.19 years; in 2022, it was 79.05 years.⁴ A healthy person can easily live into their 90s.

A simple rule by itself, while helpful, isn't enough. A person should consider having a financial plan well in advance of retirement. A financial plan is a much more thoughtful and informed way to make decisions given all the variables and unique circumstances. Unfortunately, when it comes to a person's retirement quality, we're often not given a second chance.