Could the 4% rule need to be reevaluated for new retirees?

Could the 4% rule need to be reevaluated for new retirees?
Could the 4% rule need to be reevaluated for new retirees?
  • Withdrawing 4% annually from retirement accounts is a widely used strategy to safely extract funds without risking depletion of funds in the future.
  • Morningstar suggests that new retirees should exercise caution due to lower expectations for long-term stock, bond, and cash returns.
  • Experts suggested that retirees can be more flexible with their spending.

New research suggests that the 4% rule for retirement may require adjustment in 2025 due to market conditions.

The 4% rule assists retirees in calculating the annual withdrawal amount from their accounts, ensuring they have a high chance of not depleting their funds over a 30-year retirement duration.

Retirees withdraw 4% of their nest egg in the first year, and for subsequent withdrawals, they increase the previous year's amount by inflation.

The "safe" withdrawal rate decreased from 4% in 2024 to 3.7% in 2025, as a result of long-term assumptions in the financial markets, according to Morningstar research.

The optimal tax bracket for a Roth IRA conversion is being debated. The Senate is set to vote on a Social Security bill that will benefit some pensioners. The 'vibecession' has ended, and optimism is gaining momentum.

Morningstar analysts report that expectations for stock, bond, and cash returns over the next 30 years decreased compared to the previous year. As a result, a portfolio split 50-50 between stocks and bonds would have less growth.

Retirees can generally deviate from the 4% retirement strategy if they're willing to be flexible with annual spending, according to Christine Benz, director of personal finance and retirement planning at Morningstar and a co-author of the new study.

She suggested reducing spending in down markets.

"Benz warned that the assumptions underlying the 4% rule are excessively conservative. He emphasized that the goal is not to frighten people or prompt them to spend less."

How the 4% rule works

Growing one's nest egg is easier than drawing it down.

Withdrawing a large amount of money during the early years of retirement, particularly during a downturn, increases the likelihood of running out of funds in the future.

The opposite risk is of being too cautious and living below one's means.

The 4% rule aims to guide retirees to relative safety.

If the cost of living increases by 2% annually, the investor's withdrawal amount will also increase by 2% each year.

According to Morningstar, the formula has a 90% probability of having money remaining after a three-decade-long retirement, from 1926 to 1993.

The first-year withdrawal on a hypothetical $1 million portfolio drops to $37,000 with a 3.7% rule.

The 4% rule framework has some drawbacks, as stated in a 2024 Charles Schwab article by Chris Kawashima and Rob Williams, directors of financial planning and managing director of financial planning, retirement income, and wealth management.

They wrote that the investment portfolio is a 50-50 stock-bond mix that doesn't change over time, without mentioning taxes or investment fees.

CNBC Retirement Survey: 44% of workers are 'cautiously optimistic' about reaching retirement goals

It's also "rigid," Kawashima and Williams said.

This isn't how most people spend in retirement. Expenses may change from one year to the next, and the amount you spend may change throughout retirement.

How retirees can tweak the 4% rule

Benz suggested some tweaks and adjustments that retirees can make to the 4% rule.

If retirees can accept spending less in their later years, they can safely spend more in their earlier years of retirement.

In 2025, the tradeoff would result in a 4.8% first-year safe withdrawal rate, which is higher than the previously mentioned 3.7% rate, according to Morningstar.

The cost of long-term care could significantly impact retirees' spending in the future, as stated by Benz. For instance, the average American spent $6,300 per month on a home health aide and $8,700 per month on a semi-private room in a nursing home in 2023, according to Genworth's latest cost of care study.

You're Retired! Now What?

Benz suggested that investors can increase their returns by adjusting their withdrawals and investments based on market conditions.

Delaying Social Security claiming to age 70 can increase monthly payments for life, according to a financial expert. The federal government adds 8% to your benefit payments for each full year you delay claiming Social Security benefits beyond full retirement age, until age 70.

The decision to delay Social Security claiming age depends on the source of household income. It is better to continue living off job income rather than relying heavily on an investment portfolio to cover living expenses until age 70, according to Benz.

by Greg Iacurci

Investing