Beyond the 4% rule: A modern look at retirement spending

More flexible approaches to retirement spending might help you make the most of your retirement.

For decades, the 4% rule has been the golden standard of retirement spending: You withdraw 4% of your investment portfolio in the first year of your retirement and then adjust for inflation each year, to make your retirement savings last. But with today’s longer lifespans, unpredictable markets and rising costs, it might be time to rethink this plan. Here, we’ll explore how the 4% rule works, where it falls short and modern retirement spending strategies that might offer more flexibility and peace of mind.

Understanding the 4% rule

The 4% rule became popular in the 1990s. It’s based on the idea of a balanced portfolio of 50% stocks and 50% bonds and assumes inflation will remain steady and markets will perform as they historically have. Under those conditions, if you withdraw 4% of your portfolio in the first year of retirement and adjust that amount for inflation each subsequent year, you won’t spend your retirement savings too quickly.

Potential flaws

One of the main problems with the 4% rule is that it can be overly rigid. It doesn’t account for market swings, and it can be inefficient if you underspend. And historical data may not reflect future returns.

The biggest problem: Sequence of returns risk

The 4% rule doesn’t account for sequence of returns risk, or the danger of retiring just before or during a market downturn. This risk is greatest in the early years of your retirement because those losses are locked in by withdrawals and there is less money to recover when the market rebounds.

If you’re retiring into a down market and facing sequence of returns risk, you might have to adjust your withdrawal plans, or you could risk depleting your retirement savings faster than expected.

Possible advantages

Using general rules of thumb like the 4% rule to guide your retirement planning keeps things simple. There are no complex strategies or market conditions to worry about.

The psychology of retirement spending

Retirement can be an emotional transition, especially as you move from saving money to spending it. But as you try to find the right balance, it’s important to remember that planning for your golden years isn’t just math. It’s making sure you have the life you want to live.

Some retirees underspend because they worry about running out of money. Others overspend early, assuming they’ll cut back later. Our behavior biases like loss aversion, when watching the balance decrease hurts more than watching it increase feels good, and anchoring to past income often drive our decisions, making it hard for us to adapt to changing markets and new needs. Building a flexible spending plan that looks beyond the 4% rule retirement plan can help.

Life phases in retirement

Spending in retirement isn’t linear. Spending often peaks in the early years of retirement, when we’re on the go and embracing things like travel, and then dips in mid-retirement as we slow down before it rises again in our later years due to increased health care expenses.

It’s important to recognize the different stages of your retirement and find a withdrawal strategy that lets you adapt to your changing lifestyle and needs.

Personalizing your withdrawal strategies

For many people, a one-size-fits-all approach like the 4% rule isn’t the best solution. Your withdrawal strategy for your retirement spending should be based on your personal level of risk tolerance, your lifestyle preference and your family dynamics.

Alternative strategy: The guardrail method

This strategy adapts to market changes by adjusting your spending. You set “guardrails” around your target withdrawal rate, let’s use 10% as an example. If the market performs poorly and your spending rises above the upper guardrail, you cut spending by about 10%. If the market soars and your withdrawal rate drops below the lower guardrail, you increase spending by 10%. This dynamic approach can help keep you from overspending or overcorrecting.

Alternative strategy: The bucket method

Think of your retirement assets as three specific buckets:

• Bucket 1 (one to three years): Cash or short-term savings for immediate living expenses, like housing, groceries and health care
• Bucket 2 (three to 10 years): Bonds and balanced funds that can refill Bucket 1 as needed
• Bucket 3 (more than 10 years): Stocks and growth-oriented investments to provide long-term returns and refill Bucket 2

This can help you cover your short-term needs even in periods of market uncertainty, giving you time to recover from market downturns. It may feel familiar, as many people use a bucket approach to saving during their working years, with separate “buckets” in their household budgets for immediate needs like groceries and long-term financial goals like buying a home or paying for college.

Guaranteed income and safety nets

No single method of retirement planning or spending is perfect, which is why it’s important to create a personalized retirement income strategy. In addition to your retirement savings, you may benefit from having a mix of pensions, Social Security or other guaranteed income sources, such as annuities. These predictable income streams can help cover your expenses and keep you a float in times of market uncertainty and reduce pressure to sell investments in a down market.

Many retirees struggle to balance control over their budget with their sense of financial security, so it can be helpful to have these safety nets. With guaranteed sources of income in place to cover committed expenses, you can feel more comfortable spending in your retirement if you’re anxious about running out of money.

Other considerations for your spending plan

Consider your unique needs. For example: What are your health care needs, and how do you anticipate they’ll change in the future? Will you need long-term care? You’ll want to make sure your plan budgets for those possibilities and anticipates how they’ll impact your savings and spending.

You’ll also want to consider your family and whether you’ll want to use some of your retirement income or savings to help your children financially, travel to see them, donate to charities or build a financial legacy. These can be important, emotionally fraught decisions that can have a big impact on how you approach spending in your retirement years.

The bottom line

Retirement spending is deeply personal. The 4% rule is a useful starting place, but it’s not a perfect fit for everyone or every situation. A flexible, personalized withdrawal plan is key to successfully navigating fluctuating markets and your changing financial needs.

Working with a financial planner can help you move beyond rigid rules to develop an adaptive, human-centered plan that can help ensure you enjoy the retirement you’ve earned.