The history of this rule
In 1994, financial adviser Bill Bengen published a paper stating that retirees should plan to withdraw 4% of their assets every year, increasing or decreasing that distribution annually based on inflation.
Bengen had studied several decades worth of statistics on retirement and stock and bond returns, asking himself if retirement portfolios from the time he studied could theoretically last up to 50 years.
He found that the answer was generally yes, if retirees withdrew no more than 4% of their assets per year. And in any case they could reasonably expect their funds to last 30 years.
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Where the rule stands nearly 30 years later
For two decades, the 4% rule served as the rule of thumb for financial planners and retirees in determining their withdrawal rate.
Part of what made the rule so popular is it was straightforward to understand and follow. And for those who worried about running out of money during retirement, adhering to a rule provided some assurance and peace of mind.
However, the major problem with this rule is that it is unrealistically rigid for most people.
Moshe Arye Milevsky, a finance professor at York University’s Schulich School of Business in Toronto, Canada, explained his distaste for the rule in a presentation for the Financial Planning Association of Canada in the fall of 2021.
Milevsky argues that not only does its success require strictly following the principle every year, it doesn’t take into account any lifestyle or market changes outside of inflation. When someone commits to the rule for their retirement, they’re locking themselves into a strategy for 30 years that requires them to stay the course no matter what.
A better strategy, Milevsky says, would respond to multiple variables, like a retiree’s age, where the retirement income is saved or invested and personal goals for retirement.
Also, the strategy is based on the market’s past performance, which isn’t a predictor of future performance.
Even Bengen himself has been compelled to revisit the rule in the last three decades to update it.
That’s because his original research only included two asset classes: Treasury bonds and large-cap stocks. Now, with a third class, small-cap stocks, he believes that 4.5% would be a safe withdrawal.
Bengen has studied retirees using the 4% rule and found “they’re doing well… They’re successful with that withdrawal rate even though they’re in a low interest-rate environment.”
In an interview with Barron’s in 2021, he said he believes the original 4% rule will continue to hold up unless we reach “a severe inflationary environment.”
With an inflationary environment now upon us, Bengen recommended last month that retirees make adjustments to their expenses as soon as they can.
"Inflation is something you need to deal with now, even more so than bear markets."
That being said, most retirees would be best served by consulting with their own financial adviser about the withdrawal strategy that best suits their financial situation.
— With files from Samantha Emann
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