What is the 4% Rule?


Retirement is the moment when we stop working for income. Sometimes, this is planned and desired. Other times, it is forced on us by our employer or health.

As Christians, we view our retirement years differently than most. The Great Commission doesn’t stop when retirement starts. While some rest is good and biblical, our retirement years are not to be characterized by years of leisure but by Kingdom advancement. Saving wisely for retirement allows us greater freedom to serve and minister to others during our retirement years.

One of retirees' most significant challenges is determining how much they can withdraw from their savings without risking outliving their assets. The 4% withdrawal rule has become a popular guide among the available strategies. Let's explore this rule and how it can assist with retirement planning.

What is the 4% rule?

The 4% rule is a guideline used to determine a sustainable withdrawal rate from a retirement portfolio. Coined by financial planner William Bengen in the early 1990s, this rule suggests that retirees can withdraw 4% of their initial retirement portfolio balance annually, adjusted for inflation, over a 30-year retirement period without exhausting their savings. The 4% rule is grounded in historical market data and statistical analysis.

So, how does the 4% rule work?

First, determine the initial withdrawal. The first step in applying the 4% rule is calculating 4% of the total value of your retirement savings at the time of retirement. For example, if you have $1 million saved, the initial withdrawal would be $40,000.

Then, consider inflation adjustments for each year. The withdrawal amount is adjusted annually for inflation to maintain purchasing power over time. For instance, if inflation is 2%, the $40,000 withdrawal would increase to $40,800 in the second year. For year three, the amount would be $40,800 plus the inflation adjustment.

Finally, monitor your portfolio. Throughout retirement, it's important to monitor the performance of your investment portfolio. In down years, it might be prudent to withdraw less to avoid depleting your savings prematurely.

What are some other factors to consider?

While the 4% rule offers a helpful starting point for retirement planning, it's important to recognize that individual circumstances may warrant adjustments. Here are some factors to consider:

1. Life expectancy. If you anticipate a longer retirement or have a family history of longevity, you may need to adjust your withdrawal rate accordingly.

2. Asset allocation. Your portfolio's allocation between stocks, bonds, and other assets can significantly impact its sustainability. A well-diversified portfolio may offer more stability during market downturns.

3. Healthcare costs. Rising healthcare expenses in retirement can pose a significant financial burden. Determining your withdrawal rate is crucial to factoring in potential medical costs.

4. Sequence of returns. The order in which investment returns are realized can influence portfolio longevity. Experiencing poor returns early in retirement can deplete savings more quickly than if those returns occurred later.

While the 4% rule has been widely adopted as a conservative retirement planning guideline, it has limitations. First, the historical data used to develop the rule may not accurately reflect future market conditions, particularly in an environment of low interest rates and high market volatility. Second, with increasing life expectancies, retirees may need to plan for longer retirement periods than the 30 years assumed by the rule. And finally, rigid adherence to a fixed withdrawal rate may not account for changes in financial needs or unexpected expenses during retirement.

Nonetheless, the 4% withdrawal rule serves as a helpful guide for retirement planning, providing retirees with a starting point for determining sustainable withdrawal rates from their savings. However, retirees should approach retirement planning holistically, considering individual circumstances, market conditions, and potential risks. If you feel like you cannot do this alone, consider getting a financial professional to help.

Prepare well for your retirement years so that they can be some of the most Kingdom-advancing years of your life.