Why new retirees may need to reconsider the 4% rule

A popular retirement strategy known as the 4% rule may need some recalibration before 2025 based on market conditions, according to new research.

The 4% rule helps retirees determine how much money they can withdraw from their accounts each year and be relatively confident that they won’t run out of money over a 30-year retirement period.

Under the strategy, retirees tap 4% of their savings in the first year. For future withdrawals, they adjust the previous year’s dollar figure upward to account for inflation.

But that “safe” withdrawal rate fell from 4% in 2024 to 3.7% in 2025, reflecting long-term assumptions in financial markets, Morningstar said. research.

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Expectations for returns on stocks, bonds and cash over the next 30 years have fallen from last year, according to Morningstar analysts. This means that a portfolio split of 50-50 between stocks and bonds would deliver less growth.

While history shows the 4% rule is a “reasonable starting point,” retirees can generally deviate from retirement strategy if they’re willing to be flexible with annual spending, says Christine Benz, director of personal finance and retirement planning at Morningstar and a co-author of the new study.

That could mean, for example, cutting spending in declining markets, she said.

‘We are cautious about the assumptions underlying this [the 4% rule] are incredibly conservative,” Benz said. “The last thing we want to do is scare people or encourage people to underspend.”

In many ways, taking the nest egg down is more difficult than growing it.

Taking out too much money early in one’s retirement years – especially in declining markets – generally increases the chance that a saver will run out of money in later years.

There is also the opposite risk: being too conservative and living well below your means.

The 4% rule is intended to guide retirees to relative safety.

Here’s an example of how it works: An investor would withdraw $40,000 from a $1 million portfolio in the first year of retirement. If the cost of living increases by 2% that year, the withdrawal would increase to $40,800 the following year. And so on.

Historically (covering a period from 1926 to 1993), the formula has produced a 90% chance of having money left over after a three-decade retirement, according to Morningstar.

Using the 3.7% rule, the first year withdrawal of that hypothetical portfolio drops from $1 million to $37,000.

That said, there are some downsides to the 4% rule framework, according to a 2024 Charles Schwab report. article by Chris Kawashima, director of financial planning, and Rob Williams, director of financial planning, retirement income and wealth management.

For example, it doesn’t include taxes or investment fees, and applies to a “very specific” investment portfolio — a 50-50 stock-bond mix that doesn’t change over time, they wrote.

It’s also “rigid,” Kawashima and Williams said.

The rule “assumes that you never have years where you spend more or less than inflation is rising,” they wrote. “This is not the way most people spend their retirement. Expenses can change from year to year, and the amount you spend may change during your retirement.”

There are some tweaks and adjustments retirees can make to the 4% rule, Benz said.

For example, retirees generally spend less in the later years of their retirement, in inflation-adjusted terms, Benz said. If retirees can retire and agree to spend less later, it means they can safely spend more in their earlier retirement years, Benz said.

This trade-off would yield a safe first-year withdrawal rate of 4.8% in 2025 – much higher than the aforementioned 3.7% rate, according to Morningstar.

Meanwhile, long-term care is a big “wildcard” that could increase retirees’ spending in later years, Benz said. For example, the average American would pay about $6,300 per month for a home health aide and $8,700 per month for a semi-private room in a nursing home in 2023, according to Genworth’s latest report. costs of care study.

In addition, investors may want to give themselves a little raise when markets rise significantly in a given year, and reduce withdrawals when markets fall, Benz said.

If possible, delaying Social Security until age 70 — increasing monthly payments for life — could be a way for many retirees to increase their financial security, she said. The federal government adds 8% of your benefit payments for each full year you delay claiming Social Security benefits afterward full retirement ageup to 70 years.

However, this calculation depends on where households get their money to defer the social security age claim. For example, continuing to live off work income is better than leaning heavily on an investment portfolio to finance living expenses until age 70, Benz said.