Rethinking the 4% Retirement Withdrawal Rule

Personal finance rules of thumb can be useful, but they can also fall out of step with changing markets, inflation, and retirees’ needs. Some experts believe that is now true of the 4% rule.

The guideline says retirees should withdraw 4% of their savings in the first year of retirement, then increase that amount for inflation in later years. But with people living longer and the cost of health care and other necessities continuing to climb, that rate may no longer be enough.

The guardrails approach

One alternative retirement specialists recommend is the guardrails method. It adjusts withdrawal rates based on market performance, while setting both a lower and upper limit. For instance, retirees using this strategy might decide never to take out more than 5% of their portfolio in any one year, even after strong market gains.

Because markets do not rise every year, retirees also need protection when investments decline. A floor of 3% can help provide income even during weaker market periods.

That lower guardrail can help prevent a serious drop in living standards, while an upper limit such as 5% allows retirees to benefit from gains and shift some money into safer holdings without giving up exposure to growth assets. If a 5% withdrawal target fits better, the guardrails could be set at 4% and 6% instead.

Other ways to adjust

In addition to using a range such as 3% to 5% depending on market conditions, retirees can make other changes to help protect their savings.

One option is to begin with a slightly lower target withdrawal rate, such as the 3.9% starting point Morningstar suggests.

Another is to avoid inflation increases when possible. Keeping withdrawals flat preserves more money in the portfolio, which can be especially helpful if markets perform well.

Keep an eye on spending and investments

The guardrails strategy requires flexibility, so it is not a simple set-it-and-forget-it approach. Retirees need to review portfolio performance each year and decide what withdrawal rate makes sense. Those who prefer automatic withdrawals might choose a baseline rate, such as 3%, with monthly distributions and then decide later whether to withdraw more or less.

Retirees can also protect their savings by reducing spending when markets are weak.

Ultimately, the best withdrawal strategy is the one that matches your goals and financial situation, rather than one that only follows a rule of thumb.