Time to Rethink Your Retirement — the 4% Rule Just Changed

What was the 4% rule?

Created in 1994 by California-based financial adviser William Bengen, the 4% rule establishes the maximum amount you can safely withdraw from your savings each year to ensure you don’t run out before you die. That’s why Bengen dubbed his rule “Safemax.”

So to be safe, the 4% rule says you should aim to spend no more than 4% of your total retirement fund in the first year, then adjust that amount in subsequent years for inflation. It assumes you’re using a tax-advantaged account and you might live for 30 years after retirement.

Unfortunately, the amount of money you’d need to stick to the 4% rule can be quite daunting. If you want to maintain an annual income stream of $50,000, you’d need to have $1.25 million when you retire.

Bengen updated his Safemax guideline to 4.5% in 2006 — slightly more manageable — but many financial advisers have continued to recommend 4% as the maximum withdrawal during the first year.

However, Bengen recently offered an entirely new perspective on his time-honored rule of thumb, and it could make saving for your retirement a whole lot easier.

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How has the rule changed?

In an article for the October issue of Financial Advisor Magazine, Bengen explains that the 4% rule was always based on the worst-case scenario: someone who retired in October 1968.

The ill-fated retiree would see poor returns on their investments during a bear market that lasted 14 years. At the same time, inflation soared, sapping the purchasing power of the money they’d saved up.

Under these conditions, 4% was the maximum amount you could withdraw each year and still live comfortably.

However, Bengen says, workers who retired in better times could have and should have spent more. Between the years 1926 and 1990, the average Safemax was 7%, and at certain points it reached as high as 13%.

So is 4% or 4.5% too conservative? While you can’t predict the future, Bengen says you should open your eyes to current conditions instead of blindly following the rule.

Speaking to the media after his article’s release, Bengen suggested that 5% seems like a safe number today. That may not seem like a lot, but it actually makes a huge difference. By adopting this new guideline, you would need to save $250,000 less in order to keep your yearly income at $50,000.

How do I save enough to live well?

Even if you’re aiming to withdraw just 5% of your savings each year, gathering a million bucks or more before you leave the workforce can be a tall order.

Here are a few moves you can make now to speed up your savings:

• Get help from an expert. Consulting with a certified financial planner (CFP) is one of the smartest ways to shore up your retirement strategy. A CFP can build you a personalized plan from the ground up, and these days connecting with one is easier than ever. Companies like Facet Wealth offer financial planning services entirely online, which means expert advice is only a few clicks away.

• Refinance your mortgage. Interest rates are lower than ever right now. Trading your current mortgage for one of the incredibly cheap loans people are getting today could save you tens of thousands over the coming years. Just be aware that the upfront fees can be substantial, so make sure a refi is worth it before you take the plunge.

• Keep your credit score in good shape. Your credit score is important at any age — even in retirement. Maintaining a good score now will qualify you for lower interest rates, which will free up more money to put toward your retirement fund. If you’re not sure where your score stands, you can check it for free online in just two minutes.

• Monitor your monthly spending. Getting into the habit now will make it easier for you to stick to the 5% rule once you’ve hung up your work clothes for good. While tracking your spending, you should look for any opportunities to reduce your monthly bills. For example, by comparing car insurance rates online you may be able to find the same coverage you currently have for up to $1,100 less per year.