Is the 4% Rule of Retirement Still Good Advice?

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Many financial advisors, past and present, often use the "4% rule of retirement" when determining how much their clients need to save for a comfortable retirement. This rule has you take 4% of your total nest egg when you retire and use it as your baseline withdrawal, adjusting the figure upward for inflation in future years. However, in recent years -- given the stock market's volatile performance and the persistent low-interest environment -- many experts are questioning whether or not the rule still applies. We asked three of our contributors to weigh in on the debate.

Jason Hall: If you've built up a large enough retirement portfolio, then yes, the 4% rule is still a solid rule of thumb. Unfortunately, the vast majority of people simply haven't done that. 

According to Vanguard's most recent "How America Saves" report, the median 401(k) balance in accounts the company manages was between $73,000 and $77,000 for those over age 55 in 2014. That's $257 per month in income, based on the 4% rule.

Fidelity's recent 401(k) and IRA savings analysis report said that the combined average 401(k) and IRA average balances combined for $188,000, good for $627 per month for those with the average combined balance. Unfortunately, average account balances are almost always much higher than what most people have, because a very small number of very high-wealth accounts will skew the average. 

Bottom line: The 4% rule may work fine for you, if 4% of your retirement savings each year would be enough to cover your expenses, when combined with Social Security, pensions, or other retirement income, and also leave you with a substantial nest egg for higher costs as you age.

But at the same time, if your retirement savings is small, and taking 4% each year wouldn't really make a big impact, you may be better off taking no (or the minimum once over 70 1/2) distribution, and saving as much of that nest egg for later as you can. Early in retirement, your ability to generate extra income through work or other means will be much greater than when you are older. If that's your situation, the 4% rule is out. 

Dan Caplinger: I've supported the use of the 4% rule for general planning purposes in the past, and it does have the benefit of producing a number that can guide your investing decisions. But in reality, it's rare for retirees actually to follow the rule, because changing market conditions almost always lead retirees to pull back on spending regardless of what the rule says.

For example, 2016 has begun on a sour note in the stock market, with major market benchmarks having quickly fallen to double-digit percentage losses. Despite that fact, the 4% rule says that retirees should ignore market volatility and blithely take the distribution that was previously calculated for them. In some cases, the 4% rule would tell retirees to withdraw 5%, 6%, or even more of the current value of their portfolios in a down market that lasts several years. Most retirees don't have the confidence to do that, even though historically, the rule has worked during past bear-market environments.

If you're willing and able to cut your withdrawals in tough times, then you don't need to limit your withdrawals to 4% during good times. In actual use, the 4% rule provides a cushion that's often bigger than necessary given how people actually behave during downturns. That's not terrible, but it can lead to less than ideal decisions by making you build up a bigger nest egg than you might truly need.

Matt Frankel: My answer is "it depends," and both Jason and Dan make some good points. While the 4% rule certainly isn't perfect, it's still a useful rule of thumb.

It's not perfect because it makes some assumptions, such as fairly steady market returns and steady post-retirement expenses. If there is a long period of poor overall investment returns, withdrawing 4% of your account each year can drain your savings too quickly. Also, if you have a particularly expensive year after retirement -- a lot of unforeseen medical expenses perhaps -- you can run into a similar problem of money flowing out of savings much quicker than it's being replenished by your investments.

Still, I like the 4% rule because it gives investors a solid retirement "number" to shoot for. For example, if I determine that I'll need $60,000 per year after I retire, and Social Security will give me $20,000 of this, the 4% rule says I should have $1 million in savings to sustainably make up the difference.

Just be aware that it can be a good idea to cut back on spending when your investments aren't performing well, or after spending more than you plan on in a certain year. The bottom line is that as long as you're willing to be somewhat flexible in your post-retirement use of your savings, the 4% rule can provide some good guidance.