The man who created the 4% rule for retirement savings now wants you to spend more — says it's a 'shame' when retirees can't enjoy their money

In an interview with Business Insider, Bengen said his influential 4% rule of thumb should now be closer to 4.7% for retirees who want to prepare for the worst. But under what he considers more realistic conditions today, he actually recommends a starting withdrawal rate of 5.5%.

It may sound like a small adjustment, but it could have major ramifications for how savers plan for retirement, and how much they allow themselves to spend once they get there.

How the 4% rule came to be

Under the 4% rule developed by Bengen in 1994, retirees were advised to withdraw 4% of their portfolio in the first year of retirement. In subsequent years, they would adjust that initial dollar amount for inflation.

Historically, the approach was designed to make a portfolio last roughly 30 years, including through some very bad stock market conditions.

Bengen’s update reflects decades of additional research, as well as his assessment of the current market. In May, he reiterated to Morningstar his original recommendation was based on a portfolio of U.S. large-cap stocks and intermediate-term U.S. Treasurys.

When he later tested portfolios containing additional asset classes, including small- and micro-cap stocks, their historical performance and diversification benefits allowed the portfolios to withstand larger withdrawals, eventually lifting his most conservative rate from 4% to 4.7%.

The 5.5% recommendation is based on a different calculation. Rather than planning for the worst-case scenario, Bengen considers factors such as stock market valuations and expected inflation to determine a more realistic withdrawal rate under current conditions.

And it makes a real difference. Say you had a $1 million 401(k). You would start at roughly $40,000 per year under the 4% rule, versus $47,000 at 4.7% or $55,000 at 5.5%. The irony is that the original rule was so conservative that retirees who followed it historically could have ended their 30-year retirement with substantial savings left over, according to statistician Stefan Sharkansky.

Yet for many retirees, spending more is easier said than done.

Why ‘FOROM’ is so hard to shake

Even if the numbers suggest retirees can spend more, Bengen recognizes that some are more comfortable taking an ultra-conservative approach. Part of that reluctance is rooted in what he calls “FOROM,” or Fear Of Running Out Of Money — the tendency for retirees to underspend because they’re worried about exhausting their savings, even when their finances suggest they can afford to spend more.

“It dominates their philosophy in retirement,” Bengen told Business Insider, “and therefore, they’ll just simply spend a lot less than they could, which to me is a real shame because they spent all these years saving and sacrificing.”

That fear isn’t entirely irrational, though. Inflation can steadily erode retirees’ purchasing power while forcing them to draw more from their portfolios to maintain the same standard of living. Bengen himself has called inflation “the greatest enemy of retirees because it forces them to increase their withdrawals and therefore damages their portfolios.”