The Popular Retirement Rule Millions Rely On Could Leave Some Seniors Short on Cash

Planning for retirement can feel overwhelming. So when there's guidance that makes a certain aspect of it easier, it's natural to want to follow it.

One popular retirement rule that's widely cited is the 4% rule. Developed in the 1990s by financial planner William Bengen, the strategy says you can withdraw 4% of your savings during your first year of retirement and then adjust that amount annually for inflation.

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The rule gained popularity because it provides a straightforward answer to one of retirement's biggest questions: How much can I safely spend without running out of money?

The 4% rule doesn't guarantee that your retirement savings will last forever. But it's been tested under different economic and market conditions to the point where it's likely to preserve your nest egg for 30 years.

While the 4% rule is still applicable today, it has a couple of big flaws. Not only might it put your nest egg at risk of running out, but it could also leave you short on funds to do the things you've always wanted.

The 4% rule could come back to bite you

The whole point of following the 4% rule is to avoid running out of money in retirement. But the rule makes certain assumptions that may not apply to you.

It assumes you have a fairly even mix of stocks and bonds in your portfolio, that bond interest rates are at least moderate, and that you're not retiring particularly early. But if these things aren't true, the rule becomes riskier.

If you have a very conservative retirement portfolio, your investments may not generate enough income to support a 4% withdrawal year after year. The same could hold true if bond yields plunge.

Also, having your savings last for 30 years may work just fine if you retire in your 60s. But if you're retiring in your 50s -- say, because of health issues, industry upheaval, or another reason -- you may need more mileage out of your IRA or 401(k).

The 4% rule could leave you short on cash

Even if your portfolio and retirement timeline are well-suited for the 4% rule, that doesn't mean you should rush to follow it. In fact, the 4% rule may be too conservative for you.

If you have a large portion of your portfolio in stocks with a few years of living expenses in cash as a backup, you may be able to get away with taking larger withdrawals, especially when the market is doing well. If you stick to the 4% rule, you could end up underspending throughout retirement and passing away with a large chunk of your savings left over.

If you have heirs you'd like to pass some wealth along to, that's not necessarily a bad thing. But if your goal is to spend the savings you worked hard to build, it could be a problem.

Also, the 4% rule may lock you into a rigid way of thinking.

Let's say that a few years into retirement, you're given an opportunity to join friends on a month-long trip. Participating might require you to withdraw 5% or 6% of your portfolio for that one year. If you're stuck on the 4% rule, you might say no and lose out on that experience, even though you could always adjust your spending as needed in future years.

Use the 4% rule as a starting point -- but adapt it to your own needs

All told, the 4% rule is a great starting point for retirees trying to figure out how to manage the savings they've built. But following it too closely could hurt you in two exact opposite ways.

If you stick to the 4% rule, you could end up being needlessly frugal during retirement, which could impact your quality of life. Or, you might end up overspending if your investments aren't growing quickly enough, putting yourself at risk of running out of money.

Neither is what you want. So it's best to tweak the 4% rule for your specific situation.

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