Forget the 4% Rule. Here's What You Should Really Be Looking at During Retirement.

The 4% rule was developed in the 1990s by financial advisor William Bengen. According to Bengen, people could withdraw 4% of their retirement savings in their first year and then adjust annual withdrawals based on inflation without worrying about running out of money for 30 years.

As an example, let's imagine you have $1 million in retirement savings. In your first year of retirement, you would withdraw $40,000. If inflation went up by 2% in your second year of retirement, you'd withdraw $40,800. If inflation was 3% in your third year of retirement, you'd withdraw $42,024.

The 4% rule has been a rule of thumb used for decades, but times have changed, and it might not be as applicable as it was in previous years. Factors like fluctuating market conditions, lifestyle changes, and longer life expectancy call into question whether retirees should follow the 4% rule guidelines.

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Retirees should adopt a strategy that allows more flexibility

The one certainty in life is uncertainty, which is why flexibility is so important. The 4% rule has set criteria: When this happens ( inflation ), do this (adjust by inflation percentage). A better approach in the current environment could be the "guardrail approach."

The guardrail approach is a fluid withdrawal strategy that has retirees adjust their withdrawal rates based on the market's performance rather than a strict percentage based on inflation. The "guardrails" are upper and lower limits around your withdrawal rate. If your withdrawal rate goes above your guardrail, you reduce how much you withdraw; when it's below your guardrail, you increase your withdrawal amount.

The goal is to always stay between the upper and lower limits. A common method is to make 4% your baseline and then set your upper and lower limits at 5% and 3%, respectively. These percentages aren't set in stone; sometimes, people make 5% their baseline and 6% and 4% their upper and lower limits. It all depends on your personal situation.

Seeing the guardrail approach in action

Let's continue our initial example: Someone with $1 million in savings uses 4% as their baseline and 3% and 5% as their guardrails. Here's how it would work with the market declining and growing.

Market declining scenario

Initial withdrawal: $40,000

Imagine in the second year, a market decline brings your portfolio down to $820,000, but you increase your withdrawal by 2% to $40,800 because of inflation. That's just under 5% of your remaining portfolio value, so you're still within your guardrails.

Now, suppose your portfolio drops to $760,000 in the third year, but you plan to withdraw $42,024 because of 3% inflation. That planned withdrawal would be around 5.53% of your balance, putting you above your upper 5% limit. In this case, you would change your withdrawal amount to $38,000, or 5% of your current portfolio value, putting you back within your guardrails.

Market growing scenario

Initial withdrawal: $40,000

In the more favorable market growth scenario, let's assume a bull market takes your portfolio to $1.1 million, and you plan to increase your withdrawal by 2% to $40,800 because of inflation. That withdrawal is about 3.7% of your portfolio value, so you're still within your guardrails.

Let's assume the bull market continues in the third year, and your portfolio grows to $1.4 million, with you planning to withdraw $41,616 because of 2% inflation again. This withdrawal amount is below your 3% lower limit, so you would be able to boost your annual withdrawal to move back within your guardrails. A $42,024 withdrawal would be exactly 3% of the $1.4 million balance.

No strategy works the same for every person

There is no way to predict how the market will behave, regardless of how educated or "informed" the guess is. If we could, everybody could have a foolproof retirement withdrawal strategy that ensured they didn't outlive their savings.

What's most important is giving yourself grace and allowing for flexibility from year to year. In some years, that may mean tightening your budget if you're forced to lower your withdrawal amount. In other years, that could mean an extra vacation if you're in a position to increase your withdrawal amount.

In either case, what you should be looking at is what makes sense for that year, given the market conditions and your savings at the time.

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