Beyond the 4% rule: 5 alternative retirement income strategies

The 4% rule is widely known in retirement-planning circles as a straightforward yet effective way to structure your retirement income. 

The rule simply states that by withdrawing about 4% of your portfolio the first year in retirement, and adjusting the amount for inflation every year thereafter, your portfolio is likely to last 30 years or more.

The appeal of an easy-does-it retirement draw-down strategy is undeniable, but the 4% rule isn’t workable—or sustainable—for everyone. Here are a few alternatives that may offer a better fit for your retirement income plan.

Quick recap: What is the 4% rule?

Bill Bengen, a former financial advisor, developed the 4% rule in 1994 to address a common concern: How do you spend your retirement savings so your money lasts as long as you do?

Bengen did extensive research and found that if you withdraw no more than 4.2% of your portfolio the first year you retire, and adjust that amount annually for inflation, there was a 90% chance your nest egg could last about 30 years (in some of his test cases, portfolios lasted 50 years).

Flaws in the 4% rule. Although Bengen noted early and often that his “rule” was meant to be a guideline, many people initially embraced it as an almost foolproof retirement income strategy. But the method Bengen proposed was based on specifics that don’t apply to everyone. 

His calculations  focused on a tax-deferred portfolio—such as a 401(k) or individual retirement account (IRA)—with a 50-50 equity/fixed-income allocation and a 30-year retirement time horizon. As many researchers have since noted, for those with a different allocation, or longer or shorter time horizons, or variable income needs, the 4% rule might not be a sustainable retirement drawdown strategy at all.

5 alternatives to the 4% rule

A number of variables can (and should) guide your retirement income strategy, including your total account balances, your income sources, your health and likely lifespan, inflation and market conditions, and more. When you’re considering retirement drawdown strategies, you have to take into account your unique circumstances, challenges, and goals. Here are five suggestions to help you think it through.

1. Be realistic about withdrawal rates

Is withdrawing 4% of your nest egg each year realistic from an income standpoint—meaning, can you really live on that? And is it sustainable from the perspective of keeping your portfolio healthy? It’s a tricky balance.

• Some researchers have proposed lower withdrawal rates, perhaps as low as 3% per year, to help enhance your portfolio’s longevity. That’s pretty conservative, but if you keep withdrawals low in the early years of your retirement, it can help mitigate something called sequence-of-return risk—when you spend too much too quickly during a period when market returns are low, which can cause portfolio values to drop.
• Other researchers have pointed out that life is unpredictable. You might need to withdraw 2% one year and 5% another. If you go for a flexible approach, you can also think about smart ways to combine income streams. For example, if you delay claiming Social Security until age 70 (the age at which you get the maximum payout), you could dial back on portfolio withdrawals. It’s important to think creatively.

2. Maximize Social Security benefits

You want to make the most of income from non-portfolio sources—and Social Security is a big one. Although it’s possible to claim Social Security starting at age 62, you’d only get 75% of your full retirement benefit if you started then. Your full retirement age (FRA) is either 66 or 67 (depending on the year you were born).

But that’s not the end of the story. Your FRA isn’t actually when you get the maximum payout—that kicks in at age 70. If you delay claiming Social Security until you’re 70, you’ll get a monthly benefit that’s 77% higher than at age 62.

3. Adjust your asset allocation

Although Bengen’s original research was based on a 50-50 stock/bond allocation, he also found that increasing a portfolio’s equity holdings to 75% would aid in wealth creation (not just portfolio longevity). In the years since, several researchers have championed this approach—especially because people are living longer and need their portfolios to last accordingly.

You may not feel comfortable increasing your equity allocation in retirement—historically, stocks have been more volatile than bonds—but given that lower equity allocations have been found to compromise a portfolio’s staying power, it’s something to consider.

4. Strategize about required minimum distributions (RMDs)

Because you’re required by the IRS to withdraw a minimum amount from your tax-deferred accounts starting at age 72, you might want to consider whether taking required minimum distributions (RMDs) would be a better income option for you rather than following the 4% rule. 

The 4% annual withdrawal is adjusted for inflation, whereas RMDs are recalculated each year based on your actual account balances and your remaining (likely) lifespan. Thus, taking those required distributions could be a more realistic option. And if you don’t need that RMD money for your day-to-day expenses, you can certainly reinvest it back into the market. The IRS doesn’t care how you spend (or save) the RMD; they just want you to pay those deferred taxes.

5. Manage your expenses

How much you spend in retirement can have a big impact on the health of your portfolio, and it’s something you can strategize long before you retire. After all, spending has to do with your expectations (as well as your basic needs). 

Although you don’t have control over your medical expenses, for example, you can make smart choices about where you live, the taxes you pay, and other aspects of your lifestyle. And let’s not forget about investment costs. Over time, fees and taxes can take a surprising bite out of your nest egg.

The bottom line

Although the 4% rule for retirement income has its allure—and for some retirees, it may provide the right balance of income and portfolio preservation—it’s not for everyone. Retirement is complex, and you need to consider the factors that loom largest for you when constructing your retirement income plan.

Luckily, there are a number of levers you can pull, and each one can make a substantial difference to your potential income in retirement—and, as a result, your overall comfort and peace of mind.