What Everyone Gets Wrong About the 4% Rule, According to the Father of the 4% Rule

Since the 1990s, the 4% rule has been an easy way for retirees to determine how much they can safely withdraw from their retirement accounts without fear of running out of money over a 30-year period. By adjusting for inflation each year, according to the rule, retirees can couple that adjustment with their annual Social Security cost-of-living adjustments (COLAs) to maintain their standard of living.

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What everyone gets wrong

Bill Bengen, an aerospace engineer turned financial advisor, is called the father of the 4% rule. It was the early 1990s when Bengen became determined to find an answer to the question, "How much can I safely withdraw from my retirement savings each year?"

He approached the question like a science experiment, testing 400 retirement scenarios to develop the original 4% rule. Today, Bengen says that a 4% withdrawal rate is too conservative for most retirees and it may be closer to 5%.

The 4% rule has long had both fans and critics. In fact, its originator agrees with critics who say 4% doesn't work for everyone. Bengen says, "I think the term 'rule' is something that's inappropriate because it gives the impression that there's one formula that fits everybody."

He adds that every client has different needs. While 4% provides a good foundation for determining a retirement withdrawal strategy, it's not the be-all and end-all.

The issue may not be what you think

While it's natural to wonder if the 4% rule causes retirees to run out of money earlier than intended, that withdrawal rate's problem is precisely the opposite. Of the 400 different retirement scenarios he used, only one retiree -- someone who retired into a particularly rough economy in 1968 -- had a withdrawal rate as low as 4.15%. Erring on the side of caution, Bengen stuck with the worst-case scenario as he shared the news with his clients.

Of his 400 examples, the 1968 retiree represented how much a person could withdraw with the economy and market working against them. Others could safely withdraw more (some could make withdrawals in the double digits) and still be safe. Since clients often wanted to know how much they could withdraw annually if everything went south, the 4.15% rule was born. It wasn't long before the name was changed to the 4% rule for the sake of simplicity.

For most retirees, the number is easy to remember but may mean living on less money than is necessary. In other words, it's not gospel.

Tweaking the 4% rule to fit your circumstances

Recently, Bengen released a new book, A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More. Bengen now suggests that a safe withdrawal rate for most retirees is 4.7%. While the 4% (or 4.7%) rule is a strong jumping-off point, ensuring it fits your specific needs is a good idea. Determining your personalized withdrawal rate begins with asking yourself these questions:

How long am I planning for?

Obviously, you don't know how long you'll live. But to get a rough idea, consider your family history, any health issues you face, and U.S. averages. The average lifespan for a male who makes it to age 65 is 83. For a female, it's 86.

Of course, you could live much longer. This is the point at which you'll have to determine how long you want your money to last. Do you want to spend it all before you go, or are you hoping to leave some behind for beneficiaries? There's no wrong or right answer to this question; the answer provides one more planning tool.

There's also the issue of when you plan to retire. Suppose you're saying goodbye to the workplace at age 45 instead of waiting until your full retirement age (FRA). In that case, your withdrawal rate may need to be adjusted to accommodate the longer timeline.

How much money will I need in retirement?

Knowing precisely what your post-retirement budget will look like may not be possible, but you can get a good idea. This is particularly true if you remember to factor in money for healthcare costs, emergencies, travel, hobbies, and other fun things you want to do with your time.

Build a household budget based on expenses you know you'll have in retirement (like housing, transportation, and groceries) and leave room for discretionary spending.

How flexible am I?

Part of determining a withdrawal rate that will work for you is being honest about your flexibility. Let's say you need to withdraw between 4% and 5% annually. Is your budget flexible enough to allow you to withdraw less during down markets? Here's why you may want to think twice about maintaining your set withdrawal rate when the market is down:

When you withdraw during a robust market, your assets are worth more, and you must sell fewer to produce the cash you need. When the market is depressed, you must sell more assets to come up with the same sum.

If you can tweak your budget to get by on less money when the market is down, the assets you leave in your retirement account can be used to buy up more high-quality, discounted assets. As the market recovers, those assets grow, plumping up your portfolio with them.

Hint: One way to be flexible at withdrawal time is to have a cash or cash equivalent account you can draw from instead.

Bill Bengen is 100% correct when he says that every retiree has different needs, and the 4% rule isn't necessarily right for everyone. What it does, though, is give you a starting point. By adjusting the 4% rule based on your needs and being willing to make simple changes during market downturns, you can come up with a rate that works for you.

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