Does the 4% Rule Hold Up?

One of the biggest challenges of planning for retirement is figuring out how much you can safely spend . Given the gravity of a potential mistake, retirement income planning requires careful preparation and budgeting. A common retirement income guideline is the 4% rule, which suggests that you distribute  4% of your total investments annually for living expenses. As you go forward, distributions are adjusted for inflation.

But does this rule hold up and is it a good strategy for you as you plan for living in retirement? 

What Is the 4% Rule?

The 4% rule is a guideline for managing your retirement income and suggests withdrawing up to 4% of your savings each year of retirement. For example, if you have $1,000,000 saved for retirement, you will withdraw $40,000 the first year.

The idea behind this rule is that it is low enough to account for market variability and longevity. Moreover, it is easy to calculate and provides a benchmark for how much you should spend in retirement.  Economists arrived at 4% by considering both average returns on investments and potential market corrections. They also considered 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 have about 35 years combined of living expenses.

So, the question remains: Does the rule hold up today?

Does the 4% Rule Hold Up Today?

Because the rule is so popular among economists and financial professionals, it is fair to reflect on whether or not it is still relevant today. As with most financial questions, it depends. Every retirement is different, so it is impossible to have one rule of thumb that works for everyone. Retirement distribution portfolios are subject to a range of factors including investment performance, taxes, personal health and longevity, and other goals. While the 4% rule offers a good starting point for retirement income planning, it is more reasonable to look at it as a guideline rather than a rule.¹

Investment Portfolio and Taxes

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 are withdrawing from a Roth, distributions are not taxed if you meet essential criteria, and “your calculations may be different.”²

Your Expenses

Everyone's expenses will look a little different in retirement and are largely contingent on where you live, your hobbies, and your health care expenses.

Healthcare Expenses

It is no surprise 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 retirement income planning.³

Life Expectancy

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

Ultimately, many factors go into retirement income planning, and properly preparing for retirement requires significantly more consideration than just adhering to a guideline like the 4% rule.