What is the 4% rule?

The 4% rule is a guideline for how much can be withdrawn from a retirement portfolio without running out of money. It says: withdraw 4% of the portfolio's value in the first year of retirement, then raise the amount each year by the rate of inflation. In the historical US data it was tested on, a portfolio of stocks and bonds following this rule would have lasted at least 30 years in almost every period.

It comes from a 1994 study by the financial planner William Bengen, and was extended by the so-called Trinity study of 1998, which tested different withdrawal rates and asset mixes against historical US returns.

The formula

The first year's withdrawal is:

W_1 = 4\% \times V_0

and every following year it grows with inflation $\pi_t$ , regardless of how the portfolio has performed:

W_{t+1} = W_t \times (1 + \pi_t)

Turned around, the rule gives the savings needed for a desired yearly income — 25 times that income:

V_0 = \frac{W_1}{4\%} = 25 \times W_1

A simple illustration

A retiree wants €24,000 a year from the portfolio, on top of a pension:

V_0 = 25 \times 24{,}000 = 600{,}000

In the first year they withdraw €24,000. With inflation of 2%, they withdraw €24,480 in the second year, about €24,970 in the third, and so on — whether the market has risen or fallen.

What it assumes

A 30-year retirement. Longer retirements, such as early retirements, need lower rates.
A balanced portfolio, historically around 50–75% stocks.
US market history, which was among the best in the world over the 20th century. Studies using other countries' returns have found lower safe rates, often around 3–3.5%.
No costs or taxes, which reduce what can actually be withdrawn.

Limits and alternatives

Sequence-of-returns risk: a bad start is what breaks the rule; a good start usually leaves a large surplus.
Rigid spending: real retirees adjust. Flexible rules — spending less after bad years — allow higher average withdrawals with less risk of running out.
Starting conditions: rates that were safe in the past may not be safe after periods of high valuations or low interest rates.

The 4% rule is best understood as a starting point — a rough indication of how much capital a given income needs — rather than a guarantee.

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