For many workers, the idea of retirement can bring up a lot of questions—particularly, how much is enough? How much should I put in my 401(k) each year to get there? Once I do retire, what can I afford to spend each year?

The truth, of course, is that there’s no single answer for everyone. The “right” numbers depend on factors like lifestyle, local cost of living, and if a retiree will continue to work in any capacity.

But there is an oft-cited rule of thumb called the “4% rule.” This rule assumes an investor can safely withdraw 4% of their savings in the first year of retirement, and then do the same in the following years plus a bit on top to adjust for inflation. Proponents say retirees who follow this rule have a high probability of maintaining enough money for a retirement that lasts 30 years. But critics point out disadvantages to the approach, including the opinion that 4% is too conservative.

Overall, the 4% rule can be used as a good guideline to start the consideration—but even the creator of the rule says it’s been oversimplified through the years and could also use an update.

What is the 4% rule?

The 4% rule for retirement is the brainchild of financial advisor Bill Bengen. In 1994, he published an article in which he reviewed market returns data for 50 years, from 1926 to 1976, assuming a portfolio with a 50-50 split between certain holdings in the stock market and the bond market.

From there, Bengen tested various percentages to determine what would have been a safe withdrawal rate for retirements beginning in each year. The math showed him that 4% was the magic retirement withdrawal number that allowed savings to last 30-plus years—even in the worst market conditions during that period. 

Bengen called the principle “Safemax,” as in the maximum safe rate of retirement savings withdrawal, but it came to be known as the 4% rule—becoming a golden one in the world of personal finance and retirement investment portfolios. For example, the adage about saving 25 times your annual salary to retire comes directly from this rule.

How does the 4% rule work? 

Here’s how the 4% rule works in action. To make the math simple, let’s assume an investor’s total retirement portfolio, including investments and savings, adds up to $1 million. For the first year they retire, they would withdraw 4%, or $40,000. 

That figure becomes their baseline “income” when they calculate their retirement withdrawal the next year: If the rate of inflation is 2% the following year, they would add 2% of their $40,000 baseline—or $800— and withdraw $40,800.

And so it continues: The year after that they would use $40,800 as their income baseline when calculating how much to add for inflation. Lather, rinse, repeat each year.

Pros and cons of the 4% rule

Like any rule of thumb for a complex situation, there are pros and cons.

Advantages of the 4% rule

• Easy guideline for a complex consideration.

  When planning for retirement, everyone knows you don’t want to outlive your savings. But translating that into numbers can feel overwhelming, especially at the beginning. The 4% rule is an easy, straightforward place to start when considering what you can safely withdraw each year.

• Sets up predictable income.

  The 4% rule gives a solid idea of how much a retiree can withdraw each year and that income remains stable from year-to-year. That stability may be appreciated among all of the unknowns of retirement, and it can be the basis of a solid annual budget.

• Takes inflation into account.

  It’s called the 4% rule, but it really adapts each year: 4% is what a retiree withdraws in their first year of retirement but the model is set up so that in every subsequent year, they tack on additional money for any increase in cost of living.

• May curb overspending.

  Living on a fixed income is far different from receiving a steady paycheck, and without careful budgeting, it can be easy to overspend on trips or everyday expenses like meals out. Knowing one has a set 4%-plus-inflation each year can help a retiree stay within budget each month.

Critiques of the 4% rule

• Based on the worst-case scenario.

  Some critics of the 4% rule complain that it’s too conservative. After all, Bengen was explicitly hunting for a withdrawal rate that would be safe even in the worst of the 50 years he initially studied—a period that included the 1929 stock market crash, among other major downturns. Bengen titled the main chart in his original article, in part, “Assuming Worst Case From 1926-1976.” Workers who retired in better times could have withdrawn much more.

• Soaring inflation can significantly accelerate withdrawals.

  The Federal Reserve’s target rate of inflation is 2%, but the actual increase in prices each year can vary—sometimes significantly. That risk isn’t theoretical: In April 2022, the Consumer Price Index, the government’s measure of “core” inflation, increased 8.5% over the year for a four-decade high. To return to the earlier example of a retiree with $1 million in savings taking out $40,000 their first year, it likely wouldn’t be too difficult to tack on the $800 the following year to account for 2% inflation. But pulling out another $3,200 for 8% inflation cuts much deeper into savings.

• The world has changed since the ‘90s.

  It’s been almost two decades since Bengen published his article, and some of the data he studied are nearly a century old. Meanwhile, people are living longer on average. Bengen himself increased the “rule” to 4.5% and then to 5% in recent years, while noting over and over that he finds the application of the rule to be oversimplified in a way he didn’t intend.

• Doesn’t consider non-investment income.

  The 4% rule only considers investments. It doesn’t take into account side gigs like consulting during retirement, rental income, Social Security, pensions, or any other potential sources of cash. If a retiree still has income flowing in, withdrawing 4% from investments could be even more overly conservative.

The bottom line

The 4% rule assumes that most retirees can safely withdraw 4% plus the annualized rate of inflation each year and not outlive a 30-year retirement. Financial advisor Bill Bengen devised the rule after reviewing historical data on market returns.

It’s not a promise or even really a rule, but more of a guideline for those planning for retirement. Bengen himself says the 4% rule has been oversimplified by those who promote it, and he hiked that rate to 4.5% and 5% in recent years. Critics note that the rule is based on the worst-case scenario and may be too conservative, while proponents point out it can provide clarity and stability to the sometimes overwhelming retirement planning process. Saving for retirement is never one-size-fits-all, but for some investors, the 4% rule may be a place to start their planning.