It seems the 4% rule is now the 4.7% rule.
Three decades after financial planner William Bengen came up with a simple yet elegant solution to help clients balance their retirement spending, the creator of the 4% rule has updated this widely suggested practice for modern times.
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“The primary reason for the change is that my research has gotten more sophisticated,” he told USA Today [1] in an article published Sept. 1.
Bengen was originally looking for a way to explain how much a person could spend each year in retirement before running out of money. He came up with the 4% rule and his findings were published in the Journal of Financial Planning [2] in 1994. The rule stipulates that you withdraw 4% of your savings in the first year of retirement, and each year afterward, you withdraw the same amount but adjusted for inflation. The idea was that you could safely stretch your retirement savings for 30 years.
The 4% rule caught on and is now a commonly referenced “rule of thumb” in financial planning circles — though the rule has been hotly debated over the years.
Now, Bengen says it’s time to revise that number. Here’s why, and how it could impact your retirement plans.
Why the 4% rule needed an update
Part of the appeal of the 4% rule is that it provides a simple formula to solve a problem many Americans fear: that they’ll run out of money before they die.
Indeed, a recent Allianz survey found that not only are 62% of Americans not saving as much for retirement as they’d like, 64% worry more about running out of funds than death. This fear is most prominent among Gen X, who are closer to retirement than millennials or Gen Z.
But since Bengen first came up with the 4% rule in the 90s, the world has changed — a lot.
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The rule was based on a hypothetical portfolio of 50% large-cap stocks and 50% U.S. bonds — although it allowed for as much as 75% in stocks. It also used historical market returns.
Now, a more common asset split is 60/40 (stocks/bonds) or even 70/30. And retirees may have assets across a more diverse set of asset classes, which could include cash, commodities and real estate.
And, the 4% rule assumes 30 years of withdrawals. With some Americans retiring before their full retirement age or living longer than their parents and grandparents, they may need to prepare for a 35- or 40-year retirement window instead.
How the new rule works
Bengen wrote a new book, A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More, published in August, which posits a new 4.7% rule.
The 4.7% rule takes into account seven asset classes, including U.S. large-cap, mid-cap, small-cap and micro-cap stocks, international stocks, U.S. intermediate-term government bonds and U.S. Treasury bills, according to Bankrate [3].
While the new rule allows for more diversity, it also provides a more generous withdrawal rate — 4.7% is what Bengen dubs a worst-case “safemax” withdrawal rate.
A more generous withdrawal rate can help with rising costs across the board, especially when it comes to home prices, mortgage rates, home insurance premiums remain elevated.
While the 4.7% rule is a starting point, everyone’s situation is going to be different, and Bengen doesn’t suggest people follow the rule to the letter. For some, that percentage might be slightly lower or slightly higher.
For example, if you have a chronic disease and don’t expect to live well into your 90s, you may want to adjust your withdrawal rate accordingly. Your cost of living could also decrease in the latter years of your retirement, though medical costs could rise. And you may want to leave a legacy behind to your loved ones.
You’ll also want to factor in Social Security benefits, a pension and any nonportfolio income streams into your overall retirement budget, which may mean you don’t need to withdraw the entire 4.7% from your nest egg. So, it’s worth a chat with your financial advisor on how to make the numbers work for you.
One of the biggest issues, though, is that many Americans don’t have enough saved for retirement. Those aged 55-to-65 have a median of $185,000 in household retirement savings, according to the Federal Reserve’s latest Survey of Consumer Finances in 2022.
Without any savings, a withdrawal rule is a moot point.
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[1]. USA Today. “The 4% rule is now the 4.7% rule. That matters for your retirement.”
[2]. Journal of Financial Planning. “Determining withdrawal rates using historical data”
[3]. Bankrate. “The 4% rule is so 1994: Here’s the original author’s new retirement advice”
This article originally appeared on Moneywise.com under the title: The 4% rule is now the 4.7% rule, creator says — but here’s what you need to consider before splashing out
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