The 4% retirement rule
I hear people refer to the 4% rule for withdrawals in retirement, but I don’t know how you actually follow it. Do you just withdraw 4% of your nest egg’s value and increase that amount by inflation each year? What if the market drops and your nest egg’s value falls? I’m confused. –B. A., South Carolina
You’re not alone. Despite how often the 4% rule is mentioned in stories about how much you can draw from your nest egg without running through it too soon, many people still aren’t sure about the particulars of the strategy.
Does it make sense to rely on this regimen when turning savings in 401(k)s, IRAs and other retirement accounts into spending cash?
The 4% rule stems from a 1994 study by financial planner William Bengen. After testing a variety of withdrawal rates using historical rates of return, Bengen found that 4% was the highest rate that held up over a period of at least 30 years.
Here’s how the rule works: You start by withdrawing 4% of your nest egg, by which I mean the value of all your investments earmarked for retirement. For example, if you have a total of $500,000 in all your retirement accounts, your initial withdrawal would be 4% of $500,000, or $20,000.
But in order to maintain your purchasing power in the face of rising prices, you would then increase the dollar amount of that first withdrawal in subsequent years to reflect the impact of inflation.