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The 4% Rule for Retirement Is Back
Higher interest rates make it a bit safer to spend more money in retirement
By Anne TergesenFollow
Nov. 13, 2023 8:00 am ET
For those wondering if now is a good time to retire, here’s some encouraging news: The 4% rule is back.
Thanks to higher interest rates and bond yields, it is likely safe for new retirees to spend 4% of their nest eggs in their first year of retirement and then to adjust that amount for inflation in subsequent years, according to a new analysis from Morningstar released Monday.
Though 4% had long been the gospel of retirement math, retirees in recent years were warned that starting at that spending rate raised the risk of running out of money. The recommended initial withdrawal can rise and fall with projections of future market conditions and inflation.
Two years ago, Morningstar recommended starting retirement by spending 3.3% of savings. The advice proved prescient, since inflation in June 2022 recorded a 12-month increase of 9.1%, while stocks fell nearly 20% that year. Last year, the safe withdrawal rate inched up to 3.8%.
“It is relatively good news,” said John Rekenthaler, director of research at Morningstar and a co-author of the report. “Stock and bond valuations are lower and there is more cushion for investors.”
Morningstar runs 1,000 simulations of future market conditions to find the spending rate that allows retirees to maintain a steady annual income, adjusted for inflation, without running out of money in 90% of those scenarios.
The 4% spending rule emerged as the wealth-management industry’s standard advice for retirees in the 1990s, after research showed that starting at that rate would have protected retirees from running out of money in every 30-year period since 1926, even when economic conditions were at their worst.
Why the 4% rule works
Using the method, someone who retires today with a $1 million portfolio with 40% in stocks and 60% in bonds would spend no more than $40,000 in 2024 from that portfolio. Assuming inflation rises 3% next year, the investor would give himself a raise to $41,200 in 2025, regardless of the market’s performance.
The report examines the outlook for those who retired in 2022 amid simultaneous declines in stocks and bonds and high inflation, a combination that is especially challenging for new retirees.
Someone who retired with $1 million in a balanced portfolio at the end of 2021 and took the recommended 3.3% inflation-adjusted withdrawal in 2022 and this year would have about $825,000, despite the stock market’s rise this year, according to Morningstar.
If the investor continues withdrawing the same inflation-adjusted amount in future years, the odds of running out of money by the end of a 30-year retirement are now above 50%, the report said.
Those already retired should stick with the recommended withdrawal amount they began retirement with and adjust it for inflation, rather than switch to 4%.
The increase to 4% this year relies on both higher bond yields and forecasts for lower long-term inflation, which Morningstar expects to average 2.42% a year over the next 30 years. Today, the 10-year Treasury note yields 4.6%, up from near zero in 2020.
When it is safe to spend more than 4%
Retirees can spend more than 4% if they are willing to be flexible. Those able to delay retirement enough so they need only 20 years of income can use an initial spending rate of 5.4%.
The standard 4% recommendation is for a portfolio with 20% to 40% in stocks and the rest in bonds and cash. With smaller stock allocations than that, the returns could be insufficient to support a 30-year retirement. Someone with a large stock allocation risks losing so much during a bear market the portfolio wouldn’t have enough time to recover.
Those willing to reduce spending in years in which the markets decline can also spend more than 4% to start. One strategy is to forgo inflation adjustments in any year after which your portfolio incurs losses, a strategy that allows for a 4.4% initial spending rate, according to the report.
Other retirement income strategies
Another approach is to build a 30-year ladder of varying maturities of TIPS, or Treasury inflation-protected securities. Investors who hold TIPS to maturity are currently guaranteed a 2.3% return, because the bond’s principal adjusts for inflation.
The principal on the bonds that mature each year plus the income on the portfolio’s longer-term TIPS will provide inflation-adjusted spending of about 4.6% of the amount invested each year, with no risk of running out of money, the report said. That exceeds the 4% spending recommendation for a stock-and-bond portfolio. The downside is that a retiree would deplete a TIPS ladder by the end of year 30.
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Write to Anne Tergesen at anne.tergesen@wsj.com
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