Many of us spend a lot of years amassing a war chest of money for retirement. As we approach retirement, though, an important question surfaces: How much of your nest egg can you withdraw each year in order to make your money last for the rest of your life? One of the most common answers to that question is 4%. It might be best to forget the 4% retirement rule, though, since there's a better way to approach your savings.

## What the 4% rule is

Let's back up a bit and explain just what the 4% rule is. It was introduced by financial advisor Bill Bengen in 1994 and was made famous in a study by several professors at Trinity University a few years later. The rule says you can withdraw 4% of your nest egg in your first year of retirement and then adjust future withdrawals for inflation. This withdrawal strategy assumes a portfolio of 60% in stocks and 40% in bonds, and it's designed to make your money last through 30 years of retirement.

Here's how it works: Imagine you've socked away \$500,000 by the time you retire at age 65. In your first year, you can withdraw 4%, or \$20,000. In year two, you'll need to adjust that rate by inflation. Let's say inflation over the past year was at its long-term historic rate of 3%. You'll now multiply your \$20,000 withdrawal by 1.03, and you'll get your second year's withdrawal amount: \$20,600. The following year, if inflation is still around 3%, you'll multiply that by 1.03 and get your next withdrawal amount: \$21,218.

Image source: Bev Sykes via Flickr.

## Why the 4% rule is problematic

That's all fine, but there are several reasons you should think twice before subscribing to the 4% rule. For starters, you might want to have a different asset allocation than various 4%-rule models employ, such as the 60-40 split. If you have, say, 75% of your portfolio in stocks, the rule doesn't apply to that.

History is a factor, too, because the rule was created more than 20 years ago, when interest rates were higher. That meant the fixed-income portion of people's portfolios isn't producing as much income as it used to, and it will be less able to replenish funds withdrawn each year.

Then there are life spans, which have been getting longer. The 4% rule aims to make your money last for 30 years, but if you retire at 62 and live to 96, you might be quite pinched in your last years.

Next, each of us has different financial situations and needs, and every year or set of years in the stock market is different, too. If you plan to follow the rule and withdraw 4% of your nest egg in your first year of retirement, what if the stock market and your portfolio tank by 30% in the year leading up to your retirement? Such things can happen -- the S&P 500 sank by 37% in 2008. If that happens early in your retirement, you'll either be withdrawing far less than you'd planned on, or you'll be depleting your nest egg faster.