If you’ve met with a financial planner or sought retirement advice online, you’ve likely heard of the 4% rule, a guideline used by retirees to help plan how much they can safely spend in retirement without depleting their savings too quickly.
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The gist is that ideally you would spend 4% of your retirement portfolio each year in retirement, adjusted for inflation. For example, if you retired with $1 million in savings, you’d withdraw $40,000 the first year and a bit more each successive year, based on the inflation rate.
“It’s based on historical market performance, assuming a mix of stocks and bonds, and it is designed to provide steady income while preserving the principal,” said Christopher L. Stroup, CFP and founder of Silicon Beach Financial.
However, is this really the best way to approach your retirement? Stroup and other experts offered some thoughts.
The 4% rule assumes a one-size-fits-all approach, but everyone’s retirement needs are different, Stroup said.
“Factors like healthcare costs, life expectancy and individual spending habits can vary greatly from person to person. A more customized retirement plan that adjusts withdrawals based on changing circumstances (like market performance, emergency expenses or a shift in lifestyle) might be a more effective and sustainable strategy for some retirees,” he explained.
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Simply put, the reason why the 4% rule might not work for everyone, according to Christine D Moriarty, CFP with Money Peace, is that “life is not linear.”
Moriarty added, “People tend to spend more in the first year of retirement. Or they may delay retirement withdrawals and work part time. Or they may take more and delay taking Social Security.”
In other words, the “4% rule” leaves retirees at the whims of the stock market, which Moriarty said is “never a good idea” and “aging requires us to slow down.”
Additionally, she said that in retirement people may sell a house, bringing in more liquid cash to spend according to the 4% rule. “This defies logic as we may need more money if we need care,” she said.
Instead, each retiree should consider their needs, make a plan and stick to it, with an annual review to see what needs changing. “And keep your investments diverse but more conservative each year,” she said.
Jeff Mains, founder of Champion Leadership Group, feels that the 4% rule’s simplicity can sometimes be its limitation. “The rule works as a general guide, but I think its simplicity often overlooks personal variables like market volatility, spending patterns and individual life expectancy.”
He described the 4% rule as being “like using a map from 1994 to navigate today’s financial terrain — it’s helpful, but not always accurate.”
This is partly because it was created during a time when market returns and bond yields were significantly higher. “Today, retirees face low bond yields, higher market volatility and longer life expectancies, making rigid adherence to this rule risky,” Mains said.
One of the things the rule doesn’t account for is “sequence-of-returns risk — the danger of experiencing poor market performance early in retirement,” he said. “In my opinion, relying solely on the 4% rule could mean either running out of money too soon or leaving unused funds that could have enriched your retirement.
Instead consider some alternate strategies:
The bucket strategy is ideal for retirees who want a more conservative and predictable approach with a medium- to long-term time horizon, Stroup said. The bucket strategy divides retirement savings into “buckets” based on the time horizon for when the funds will be used: bucket one (short term), bucket two(medium term), and bucket three (long term).
“It works well for those with lower risk tolerance as it focuses on reducing the impact of market downturns in the early years of retirement,” Stroup said.
This strategy allows retirees to draw from more stable investments in the short term while giving their riskier investments more time to grow, which reduces the impact of short-term market volatility.
The dynamic withdrawal strategy is often used by retirees who have a longer time horizon, who are willing to adjust their withdrawals based on market performance and who have a moderate-to-high risk tolerance, Stroup explained.
“Instead of sticking to a fixed 4% withdrawal rate, the dynamic withdrawal strategy adjusts withdrawals based on the portfolio’s performance,” he said. For example, if the market is doing well, retirees can withdraw more. However, if the market is underperforming, they would be forced to withdraw less.
This approach adjusts withdrawals based on portfolio performance, Mains shared. For example, you might reduce spending during a down market to preserve capital and increase withdrawals when markets recover. It’s flexible and accounts for real-time conditions, unlike the rigid 4% rule.
Younger retirees with higher risk tolerances might withdraw more aggressively early on, assuming they can downsize later, Mains said. Conversely, those prioritizing stability might withdraw less initially and let their investments grow longer.
Mains stressed that regardless of what approach you take, retirees should revisit their plans regularly.
“Life circumstances and market conditions change, so what works at 65 may not work at 75. Flexibility is key — view retirement as a dynamic journey rather than a static phase.”
He also urged retirees not to underestimate the importance of nonfinancial aspects of retirement, like health, relationships and purpose. “A well-rounded plan goes beyond money to ensure a fulfilling life.”
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This article originally appeared on GOBankingRates.com: Why You Should Reconsider This Golden Rule of Retirement, According to Financial Advisors
