The 4 Percent Rule

Bill Nelson is a planning excellence lead consultant at Northwestern Mutual.

Most of us have something we’re afraid of—public speaking, heights, being without your cellphone (yup, “nomophobia” is a real thing). Running out of money in retirement is a common fear as well. Northwestern Mutual’s 2024 Planning and Progress Study found that among generations closest to retirement, just half of boomers+ (49 percent) and Gen X (48 percent) believe they’ll be financially prepared when the time comes. Across generations, U.S. adults believe they’ll need $1.46 million to retire comfortably, according to our study.

But there are two sides to every coin. In the case of retirement, having a savings goal and working toward it is one side. Equally important—possibly more—is your plan for withdrawing those savings in retirement. One well-known general guideline is the 4 percent rule. It provides a framework for being reasonably confident that your money will last as long as you do. It isn’t perfect, but it could be a good jumping-off point when retirement planning. We’ll look at how it works, see an example and consider the rule’s drawbacks.

How does the 4 percent rule work for retirement?

It’s tough to predict how long your money will last in retirement. To help you make a reasonable prediction, the 4 percent rule says you can withdraw 4 percent of the total value of your retirement savings in the first year that you retire. After that, you continue to withdraw the same amount each year, plus a little extra to account for inflation. This should give you a reasonable level of assurance that your retirement portfolio will last at least 30 years.

Here’s an example of how the numbers shake out. Let’s assume you have $2 million saved for retirement.

• Year 1: You’d withdraw $80,000 from your savings (.04 x $2,000,000).
• Year 2: You’d boost your withdrawal to account for inflation. For example, if inflation is running at 2 percent, your second-year withdrawal would be $81,600 (80,000 x 1.02).
• Year 3: If inflation moves to 3 percent, you’d increase your withdrawal amount again from $81,600 to $84,048 ($81,600 x 1.03).

You can also use the 4 percent rule as a quick way to calculate how much savings you’ll need to generate a certain amount of income per year (the reverse 4 percent rule). For example, let’s say you’ve determined that you’ll need $60,000 a year from your savings to live comfortably in retirement. Based on the 4 percent rule, you’d divide $60,000 by .04 to determine that you’d need approximately $1.5 million to afford the lifestyle you want.

Does the 4 percent rule work?

As with any generalized rule, there are critics who question if the 4 percent rule still makes sense. Below are some important things to consider.

How long will my money last using the 4 percent rule?

The 4 percent rule is based on a 30-year retirement. If you’re planning to retire early or think you might live longer than average, the 4 percent rule might not be adequate.

On the other end of the spectrum, you may enjoy your job and want to continue working into your 70s. Sticking to the 4 percent rule might result in a retirement that’s overly frugal, depriving you of some of the luxuries you worked hard to afford.

The 4 percent rule and your portfolio

How your retirement money is invested is another important factor. The general rule is for your portfolio to become more conservative as you get older, but it’s wise to stay invested to some degree. That can help you keep up with inflation as a retiree.

The 4 percent rule assumes you have a 50/50 portfolio (half stocks, half bonds), which could be a great split if you’re 70 or older. But in your 60s, the more ideal asset allocation is 60 percent stocks, 40 percent bonds.

That 50/50 mix made sense in the 1990s, when William Bengen created the 4 percent rule and bond yields were higher than they’ve been in recent years—though yields have seen an inflation-related spike lately. Either way, a financial advisor can talk through your risk tolerance and financial goals. Those will help determine if your portfolio should be more focused on stocks or bonds, which would impact its performance. For example, if you don’t want a lot of risk, a professional can help you make a plan that creates enough income. It’s especially important to plan for periods of low interest rates.

Digging deeper into the 50/50 mix, the rule assumes your retirement portfolio is invested in the S&P 500 and intermediate-term U.S. government bonds. So, the performance used to create the rule is limited to U.S. historical experience. At Northwestern Mutual, our investment philosophy is different. We recommend broad diversification across even more asset classes, including international stocks and bonds, real estate and commodities.

Drawbacks of the 4 percent rule

The 4 percent rule has its limitations. Keep the following things in mind:

• Market volatility could impact your portfolio: No investment is totally risk-free, including retirement funds. Market volatility is a normal part of investing. Depending on your asset allocation, your portfolio could bounce up and down in value—which might make the 4 percent rule either too risky or too conservative. When you’re ready to tap the funds, current market conditions should be considered so that you’re being efficient. The rule can’t account for today’s markets because it was built on historical market conditions.
• It relies heavily on assumptions: For example, it assumes you can stick to the formula even when the markets go down and you’re tempted to sell. The rule also assumes no taxes or investment fees, which are both factors in a sophisticated, personalized plan. And the rule’s design assumes a 30-year life span during tough economic conditions while leaving no money for future generations.
• It doesn’t account for spikes or dips in future spending: If you or a loved one faces a health crisis, that could majorly deplete your retirement savings. Planning ahead for long-term care is the best way to protect your wealth. Health care aside, the 4 percent rule might need adjustment if your expenses increase. For example, you might need extra money for home repairs. (Or you may spend less in your final 10 years of retirement compared with the first 20 years of retirement.)
   

How long can you live on the 4 percent rule?

Pulling about 4 percent annually from your retirement fund is generally considered a safe withdrawal rate, but how much you’ll ultimately need in retirement depends on things like:

• The length of your retirement.
• Your expenses and lifestyle.
• Tax considerations (because different financial tools are taxed differently).
• Other retirement income sources you may have, such as a pension, Social Security, an annuity or cash value from a permanent life insurance policy.

When you have multiple sources of retirement income, you can reduce your need to take withdrawals from investments. An experienced financial advisor can help you determine the right withdrawal rate for you.

Beyond the 4 percent rule for retirement

You can use the 4 percent rule as a starting point for determining the best way to create a sustainable stream of income from your savings. But as you approach retirement, it’s important to move away from rules of thumb and get a personalized plan that’s specific to your goals. That’s where expert help can make a huge difference. A financial advisor can help you create an ongoing retirement income strategy to make your money last for years without sacrificing the things you enjoy.

If you’re interested in taking your retirement planning to the next level, now is the time to connect with your Northwestern Mutual financial advisor. After all, the right plan for you doesn’t exist in a spreadsheet or printout. At Northwestern Mutual, we do retirement planning differently. We go beyond your retirement funds to understand your goals and needs, asking deeper questions to help identify opportunities and potential blind spots.