Wade Pfau, Ph.D., CFA

Ten Reasons Why the 4% Rule is Too Simplistic for Retirement Planning

William Bengen’s seminal study in the October 1994 Journal of Financial Planning, “Determining Withdrawal Rates Using Historical Data,” helped usher in the modern area of retirement withdrawal rate research by codifying the importance of sequence of returns risk. The problem he set up is simple: a new retiree makes plans for withdrawing some inflation-adjusted amount from their savings at the end of each year for a 30-year retirement period. What is the highest withdrawal amount as a percentage of retirement date assets that with inflation adjustments will be sustainable for the full 30 years? He found that with a 50/50 asset allocation to stocks and bonds, the worst-case scenario experienced in U.S. history was a 1966 retiree who could have withdrawn 4.15% at most. This is where the 4% rule comes from, and you can read more about it at William Bengen’s SAFEMAX.

This doesn’t necessarily mean that 4% is an appropriate withdrawal rate for every new retiree. Here are 10 reasons (some of which suggest lower withdrawal rates, and others which suggest higher withdrawal rates) why retirees should think more deeply about whether 4% is right for them.1. The U.S. historical experience is not sufficiently representative to have a clear idea about the safe withdrawal rate. The 4% rule has not worked as well in other countries, and the low current bonds yields represent a clear challenge to the sustainability of 4% for recent retirees.
2. The 4% rule is based on an assumption that investors earn the underlying indexed market returns with annual rebalancing. Investors who pay fees or who otherwise underperform the indices because of panicking and selling after a market drop other other bad timing or stock picking decisions cannot rely on 4%.

3. The 4% rule is based on a tax-deferred portfolio. For those withdrawing from a taxable portfolio, taxes will play a bigger role than you may expect. Not only are taxes paid on withdrawals, but taxes must also be paid on reinvested dividends, interest, and capital gains when they accrue and even if they are not withdrawn. This limits the chance for the portfolio to earn compound growth on those removed tax payments. I’ve not written more about this myself yet, but Bill Bengen estimated in his 2006 book that a 20 percent effective tax rate reduces his SAFEMAX from 4.15% to 3.67%.

4. The 4% rule assumes a retiree has no desire to leave a bequest or to build in a safety margin. In the worst-case scenario, wealth depletion can be expected. This causes the retiree to play a game of chicken as wealth plummets toward zero. Planning for a bequest reduces the sustainable withdrawal rate.

5. The 4% rule is based on a planning horizon of 30 years. Those with other planning horizons must adjust their withdrawal rate accordingly.

6. The 4% rule assumes only a few asset classes. What matters for sustainable withdrawal rates are the interaction of portfolio returns and volatilities. Including more asset classes can allow for different portfolio characteristics and potentially a portfolio with better return/volatility characteristics can be found.

7. The 4% rule assumes constant spending in inflation-adjusted terms throughout the retirement period. There are two questionable aspects about this which may or may not be related. First, actual retirees tend to reduce some of their discretionary expenditures as they age and spend more time at home. On the other hand, health expenses tend to rise with age. Different assumptions about how spending evolves with age have an impact on sustainable withdrawal rates. Second, because survival probabilities decrease with age, it is somewhat natural to plan for a reduced spending pattern over time. You would have to be extremely inflexible with your spending or extremely averse to outliving your wealth to prefer a strategy of constant spending over retirement. Generally, constant spending will force you to make too much of a cutback on spending in early retirement to allow for the same spending much later on when the probability of survival is quite low.

8. The 4% rule assumes withdrawals are taken from a portfolio invested with a total returns perspective. But there are many other options available to retirees building income strategies, such as fixed and inflation-adjusted immediate annuities, variable annuities (with and without guarantee riders), and bond ladders. Retirees may seek to build an income floor to make sure their basic needs will be met. A bumpy strategy of spending more before age 70 and less after may be appropriate as it is often beneficial to delay claiming Social Security. A complete strategy will involve a process which seeks to combine different income tools to best balance between one’s goals and risks to those goals

9. Optimal retirement income strategies will involve changing one’s spending in response to evolving market returns and their impact on wealth. The constant inflation-adjusted withdrawal strategy looked to be inferior to other strategies no matter the types of evaluation measures or retiree circumstances I considered.

10. The 4% rule is based on an evaluation measure which only seeks to minimize the probability that financial wealth will be depleted at some point before death. It ignores the potential magnitude of failure (that is, how much time at the end of retirement will be spent without wealth) and it ignores other resources which may be available to the retiree in the event of wealth depletion. A more complete picture of retirement income resources may suggest in some circumstances that retirees can be more tolerant about later financial wealth depletion as it will allow them to enjoy a more satisfactory early retirement period. This more complete picture would also account for when, precisely, financial wealth is depleted.

The 4% rule and the probability of running out of financial wealth are just one piece of a much larger puzzle which needs to be solved in order to fully enjoy retirement.

Next, read 7 Risks of Retirement Planning.


  1. Avatar Anonymous on June 29, 2012 at 12:19 pm

    #3 Regarding the withdrawal rates from taxable and tax deferred accounts – I agree that with taxable accounts relative return can be lost as distributions are made and gains are realized. But initial investments plus reinvestments build basis and reduce taxes on the ultimate withdrawals, which are taxed currently at favorable capital gains rates. Tax deferred account withdrawals are fully taxable on withdrawal and are taxed at your highest marginal rates. Is the implication that tax deferred accounts have such a large advantage over taxable accounts a bit missleading? Any comparison would be dependent on the current and future tax rates that will apply to a particulat taxpayer over many years. I think the main point is regardless of the type of account do not forget the taxes. The government owns a share of your investments and regardless of the timing they will get them eventually in most cases through income taxes.

    • Avatar Wade Pfau on June 29, 2012 at 1:28 pm


      You are making a good point, and I don’t have a good answer about the question you included. The effect of losing that compounding on early tax payments can be pretty big though, even if the tax rate is less. At some point I would like to dig into this more and to find out the conditions when tax-deferred and taxable may be preferable.

  2. Avatar Anonymous on July 3, 2012 at 3:01 pm

    I’d like to meet whoever said the 4% rule was simplistic. Of course there’s more to it than simply depositing a large sum of money into a bank savings account and withdrawing an inflation-adjust 4% for the rest of your retirement!

    4% inflation adjusted for 30 years can most certainly be done 98% of the time using tax-advantaged, globally-diversified portfolio, but you have to know what you’re doing. But for the educated, the 4% rule is alive and well, and quite conservative really. Considering that historical global stock market REAL returns are greater than 6% (source: Siegels “Stocks for the long run, 4th edition”), 4% NOMINAL, inflation-adjusted withdrawals in a 50/50 is just short of a walk in the park.

    Everyone would like a 100% guarantee, but this is life, Wade. No such guarantee exists. But you can get close enough to “no significant difference” as they probably said in your stats class.

    • Avatar Wade Pfau on July 4, 2012 at 5:06 am

      Thank you. And remember that it is not just the average return that matters, but also the volatility. Volatility is especially tough on retirees, because more shares are sold and lost forever when prices are down.

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