Retirement planning: What is the 4% rule and how is it useful?

Retirement planning: What is the 4% rule and how is it useful?

Retirement planning: What is the 4% rule and how is it useful? ByAshley Paul Feb 10, 2025 05:48 PM IST Share Via Copy Link The 4% rule is a way to guide retirees on how to spend their savings after they have stopped working full-time

A lot of things often change after a person retires. One of the most significant changes, however, is how much they earn and how they spend their earnings and savings, both of which may reduce significantly after retirement.

You can use 4% rule to plan your expenses after retirement. Know what it means

The 4% rule plays an important role here, posing as a point for people to start planning their post-retirement spending.

Also read: Former Amazon staffer, who began working as a janitor at 16, retires at 39 on ₹1.6-crore pension

In the mid-1990s, financial adviser Bill Bengen analysed historically marked data on stocks, shares and bonds using actual market returns from 1926 to 1976. He then analysed if, for people retiring in 1976, their portfolio would serve them for the next 30 years.

Although Bengen didn't coin the term ‘4% rule’, it came from the research he did. He observed that a first withdrawal rate of 4% allowed most portfolios of retirees to last 50 years or more.

Also read: Tips for millennials for a sound financial planning

This marked the basis of the 4% rule, which proposes withdrawing 4% of the retirement portfolio in the first year after a person retired. In the following years, the retirees are simply supposed to adjust their withdrawal rates for inflation.

The rule is easy to understand, follow and implement and is based on historical data derived from real-life scenarios of retirees. It also provides a benchmark for people who wish to strike a balance between spending and saving.

Also read: Gen-Z outpaces millennials in setting 5-Year financial plans amid economic challenges

One of the most obvious cons for the theory is that it does not account for potential market volatility, which takes the centre stage particularly in today's world. It also does not account for any future rise in expenses of retirees, which may be due to health-related issues.

Another drawback is that the rule applies best to those who only wish to plan for 30 years after their retirement. Those willing to factor in longer life expectancies will find the rule insufficient.