The 4% rule has been a long-standing guide for retirees, but it has its limitations. It assumes a 30-year retirement and market performance over the past century, which may not be realistic for everyone. Researchers have been revising the figure, with Morningstar estimating 3.3% in 2021 and 3.9% this year. William Bengen, who devised the rule, suggests a safe number could be 4.7%.
The rule's rigidity can be a problem, as it doesn't account for market fluctuations. If your portfolio doubles in a market boom, the rule would still limit you to the same inflation-adjusted amount, which could be unnecessarily frugal. Conversely, if your assets fall by a third, the rule wouldn't tell you to curtail your spending, which could lead to outliving your money.
There are ways to make retirement spending more responsive to your life expectancy and market performance. One approach is to use the 4% rule as a reference point, rather than a full plan. You can divide your current portfolio balance by your remaining life expectancy and spend that much in the coming year. The following year, you do the math again with your new portfolio balance and your new remaining life expectancy.
This actuarial approach lessens the chance you'll run out of money and lets good market returns flow through to higher spending. However, it introduces a new problem: too much fluctuation in your spending. To fix this, you can put guardrails on the actuarial approach, using the 4% rule as your anchor. You set an upper and lower band around it, say 3% of assets on the low end and 6% on the high end.
Another fix is to add a shock absorber, which caps year-to-year spending changes at plus or minus 5%. This works best for retirees with some cushion above their essential spending. Finally, you can distinguish between essential and discretionary spending, using guaranteed income such as Social Security benefits or an annuity to cover the essentials.
None of these refinements is perfect, and each retiree has personal factors that could change the math. However, a dynamic strategy with the 4% rule as a reference point is practicable without specialized software and should help you enjoy your nest egg and not outlive it.
