Does the 4% Rule Hold Up?
One of the biggest challenges of planning for retirement is figuring out how much you can spend during your golden years. Retirement income planning requires careful preparation, and budgeting.
A popular retirement income planning guideline is the 4% rule, which suggests that you live off 4% of your total investments during the first year of retirement. Then, you readjust every year in retirement based on your changing needs and inflation.
But does this rule hold up? Is the 4% rule a good strategy for you as you plan for living in retirement? Let's dive into this rule a little deeper and consider whether it's right for you.
What Is the 4% Rule?
The 4% rule is a guideline for managing your retirement income and suggests only withdrawing up to 4% of your savings each year of retirement. For example, if you have $1,000,000 saved for retirement, you will withdraw $40,000 the first year.
The idea behind this rule is that it's easy to calculate and provides a benchmark for how much you should spend in retirement. The goal of retirement income planning is to make your money last as long as you do, and the 4% rule is designed to help retirees do that.
Economists calculated 4% by considering both average returns on investments and potential market corrections. They also considered the average life expectancy of retirees. In 1990, when the rule was established, the average American man was expected to live 15 years after age 65, and the average woman just under 20 years. Using the 4% rule, retirees could expect to have about 35 years of living expenses.
So, the question remains: Does the famed 4% rule hold up today? Let's take a look.
Does the 4% Rule Hold Up Today?
Because the 4% rule is so popular among economists, it's fair to wonder whether or not it's still relevant today. The short answer: maybe. Every retirement is different, so it's impossible to have one “rule” that works for everyone. While the 4% rule offers good insight into retirement income planning, it's more helpful to look at it as a guideline than a rule.1
Today's retirees face so many factors that everyone can't subscribe to a concrete “rule,” even if it is popular. When planning out your retirement income, some things to consider include your investments, expenses, health, longevity, and goals.
Your Investment Portfolio
According to Prudential, the 4% rule assumes that “you have about 60% of your investments in equities and 40% in fixed income assets,” and it's based on a tax-deferred portfolio like a traditional IRA or 401(k) and “assumes that you'll owe tax on withdrawals.” If you're spending from a Roth, where withdrawals aren't taxed if you meet essential criteria, “your calculations may be different.”2
Your Expenses
Everyone's expenses will look a little different in retirement, depending on where you live, how much money you have saved for retirement, your health care expenses, your hobbies, and whether you work part-time.
Your Healthcare Expenses
It's no surprise that healthcare costs have gotten more expensive since the 4% rule was established in the 1990s. Today, the average 65-year-old couple can expect to spend over $300,000 on doctor's appointments and medical bills in retirement. Healthcare expenses are a significant part of your retirement income planning.3
Your Life Expectancy
In addition to having increased healthcare expenses, today's retirees live longer than they did 30 years ago. The average life expectancy in 1990 was 75.19 years; in 2022, it was 79.05 years.4
As you can see, many factors go into your retirement income planning, and properly preparing for retirement requires much more consideration than just sticking to a blanket guideline like the 4% rule. Every retirement is going to look a bit different.
As always, let us know if you have any questions.
Best,
CRA Investment Committee
Matt Reynolds CPA, CFP®
Tom Reynolds, CPA
Robert T. Martin, CFA, CFP®
Gordon Shearer Jr., CFP®
Jeff Hilliard, CFP®, CRPC®
Joe McCaffrey, CFP®
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by CRA Financial, LLC [“CRA]), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CRA. Please remember to contact CRA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. CRA is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice. A copy of CRA’s current written Disclosure Brochure discussing our advisory services and fees continues to remain available upon request or at www.crafinancial.com. Please Note: If you are a CRA client, please advise us if you have not been receiving account statements (at least quarterly) from the account custodian.
Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your CRA account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your CRA accounts; and, (3) a description of each comparative benchmark/index is available upon request.
Please Note: Limitations: Neither rankings and/or recognitions by unaffiliated rating services, publications, media, or other organizations, nor the achievement of any professional designation, certification, degree, or license, or any amount of prior experience or success, should be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if CRA is engaged, or continues to be engaged, to provide investment advisory services. Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized adviser. Rankings are generally limited to participating advisers (to the extent applicable). Unless expressly indicated to the contrary, CRA did not pay a fee to be included on any such ranking. No ranking or recognition should be construed as a current or past endorsement of CRA by any of its clients. ANY QUESTIONS: CRA’s Chief Compliance Officer remains available to address any questions regarding rankings and/or recognitions, including the criteria used for any reflected ranking.