What is the 4% Rule, and Does It Apply in the Modern World?

One of the biggest, and most common, obstacles that people run up against during retirement planning is figuring out how much you can spend during your golden years. Retirement plans require careful preparation and budgeting for expected income, and sometimes it can feel like trying to predict the future.

A popular retirement income rule of thumb is the “4% Rule” - a guideline suggesting that, during the first year of retirement, you live off four percent of your total investments. After that, readjust every year based on the changes in your personal needs and the state of the economy as a whole, including inflation.

But does this rule hold water, and is it worth considering during your own planning for living in retirement? Let’s dig deeper into the details of the 4% rule, so you and your financial professional can decide if it’s the right path for you.

What Is the 4% Rule?

As previously explained, the 4% rule is a strategy for managing your retirement income by only withdrawing up to 4% of your savings in each year of retirement. For example, if you have $1,000,000 saved for retirement, you will withdraw, at most, $40,000 during the first year.

The twofold idea behind this rule is that, for one, it's easy to calculate; it also provides a benchmark for how much you should spend in retirement, somewhere to start in thinking about your spending and cost of living. The goal of retirement income planning is to make your money last as long as you do, and the 4% rule is designed to help retirees do that.

This number was decided upon by economists, who calculated 4% by considering several factors: the average returns on investments and potential market corrections, along with the average life expectancy of retirees. In 1990, when the rule was established, the average American man was expected to live 15 years after age 65, and the average woman just under 20 years. Using the 4% rule, retirees could expect to budget for about 35 years of living expenses. With that in mind, the question remains: Do all these numbers hold up in today’s world?

Does the 4% Rule Still Apply Today?

Because the 4% rule is so popular among economists, it's fair to wonder whether or not it's still relevant today. The short answer: maybe.

This may sound obvious, but every retirement is different and dependent on the individual’s circumstances, so it's impossible to have one “rule” that works for everyone. While the 4% rule offers a good insight into the mentality with which to approach retirement income planning, it's more helpful to view at it as a starting place than a hard and fast rule.¹ Today's retirees face so many extenuating factors that every single one can't subscribe to a concrete instruction, even if it is popular. 

When planning out your retirement income, many of the things to consider include your investments, long-term expenses, current health and longevity (if it has been discussed with your healthcare provider), and all of your personal goals and aspirations.

Your Investment Portfolio

According to Prudential, the 4% rule assumes that “you have about 60% of your investments in equities and 40% in fixed income assets,” and it's based on a tax-deferred portfolio like a traditional IRA or 401(k) and “assumes that you'll owe tax on withdrawals.” If you're spending from a Roth, where withdrawals aren't taxed if you meet essential criteria, “your calculations may be different.”²

Don’t worry if these terms are daunting, your financial professional will be able to help you understand where your finances stand and, if needed, how to perform your updated calculations.

Your Long-Term Expenses

Everyone's expenses will look a little different in retirement, depending on where you live, how much money you have saved for retirement, your health care expenses, your hobbies, and whether you will work part-time.

Your Healthcare Expenses and Life Expectancy

It will come as no surprise to learn that healthcare costs have gotten more expensive since the 4% rule was established in the 1990s. Today, the average 65-year-old couple can expect to spend over $300,000 on doctor's appointments and medical bills in retirement. Healthcare expenses are a significant part of your retirement income planning.³

In addition to having increased healthcare expenses, today's retirees live longer than they did 30 years ago. The average life expectancy in 1990 was 75.19 years; in 2022, it was 79.05 years.⁴

What is the Best Way to Use the 4% Rule?

Since all of the above are far from an exhaustive list of circumstances that affect retirement spending and, more importantly, retirement income planning, hopefully you are beginning to see why it is difficult to rely on a blanket guideline like the 4% rule. Every life in retirement is going to look every bit as different as they did pre-retirement.

At the same time, just because the world has changed doesn’t mean the 4% rule has to be abandoned entirely. Instead, it can serve as a starting point for you and your financial professional during the planning process. 

After figuring up what your total savings may look like in retirement, calculate what it would look like to withdraw 4% of that total in one year. You may think it looks like far more money than you could ever spend in a year, or not nearly enough to cover all of the guaranteed expenses discussed earlier in this article. No matter what the case, you now have an idea of where to walk back or add more to your numbers, and that will allow you a stronger plan in the end.