This Popular Retirement Rule Millions Rely On Could Leave Some Seniors Low on Funds

One of the most well-known retirement rules is known as the 4% rule. This has been a staple of personal finance since the 1990s. Developed by financial planner William Bengen, the 4% rule says (in a nutshell) that if you withdraw 4% of your portfolio in your first year of retirement and adjust every year for inflation after that, your nest egg should last throughout your retirement years.

However, there are a few scenarios where the 4% rule might not be as effective. For that reason, it's important that workers make the right moves and focus on their full financial picture, including the state of the economy, when they retire. That way, they know whether or not their 401(k) retirement plan balance can last them for several decades. 

Here's more information about the 4% rule and when retirees may not want to rely on it fully.

How William Bengen developed the 4% rule

In 1994, Bengen's article about the 4% rule was published in the Journal of Financial Planning. He arrived at the 4% rule after studying years of stock market returns. He reviewed portfolios during this time and analyzed their performance over decades, including inflation adjustments and economic upheavals.

He determined that a withdrawal rate of 4% would allow a retirement portfolio to last for 30 years. However, these days, retirees may have a longer time horizon or a different portfolio allocation than Bengen studied.

A fixed withdrawal can be harmful in a down market

The biggest risk with following the 4% rule is the long-term impact of people's withdrawal rates if they make their first withdrawal in a down market. Someone who retires during strong economic times may be able to comfortably make a 4% withdrawal without it having a negative impact on their future withdrawals.

However, someone who retires in the middle of an economic downturn or serious recession will have a much harder time recovering their overall portfolio. Essentially, retirees who have to sell during the bottom of the market will have a much different retirement experience than those who retire during an economic boom.

Many people are living longer and may need a larger portfolio

People now have longer lifespans than ever before. According to the National Center for Health Statistics, those born in 2024 now have a life expectancy at age 79. Though a longer lifespan is a positive, it also means that many retirees will need their portfolios to last longer than the 30-year horizon proposed when the 4% rule was published.

For many people, that may mean increasing their 401(k) contributions or working longer to ensure they have a large enough nest egg to last them during retirement.

Taxes can cut into retirees' cash flow and lifestyle plans

Another important distinction is that the 4% rule does not account for the taxes that retirees may have to pay on their withdrawals. 

If retirees have a traditional 401(k) or a traditional IRA, their withdrawals are taxable. Withdrawals can also increase retirees' overall income, which could make part of their Social Security benefits taxable. All of this can cut into retirees' cash flow and lifestyle plans.

Health care costs in retirement are rising every year

The cost of health care has also risen since Bengen originally published his 4% rule data. 

According to Fidelity, those aged 65 and up can expect to spend over $170,000 on health care during retirement. These costs can reduce the funds retirees have available for their everyday living expenses.

Being flexible with your withdrawal strategy may be more practical

Ultimately, treating the 4% as a fixed strategy can be problematic, especially during times of economic turmoil. Rather, using the 4% rule as a guideline and adjusting it as needed can help people personalize their withdrawal strategies.

After all, different retirees will have their own spending patterns, family needs, and even other income sources, such as Social Security or business income, that may affect how much they actually need to withdraw from their retirement plans.

How retirees can get help with financial planning

For those unsure whether they have enough money to last through retirement, seeking advice from a financial planner may be helpful. The reason is that a financial planner can sit down and review an individual's or couple's goals, retirement accounts, and specific needs.

Not everyone will have the same retirement savings, health care needs, or retirement lifestyle goals. A financial planner can assess all of the data given and give advice that can help someone's nest egg last throughout their golden years.

Bottom line

In order to have a stress-free retirement someday, it's important that people make a clear withdrawal strategy. While Bengen's 4% rule is a long-standing example of thoughtful retirement planning, workers should remain flexible with their withdrawal strategy rather than following a strict, fixed rule.

 For those who want to make sure they're on track for retirement and preserving their wealth for decades, speaking with a financial planner can help.

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