How to plan for retirement using an online calculator
Retirement calculators can give you an idea of when you’ll financially be able to retire.
Problem Solved
Three decades ago, financial adviser Bill Bengen created a retirement principle called the 4% rule. It went viral.
Now, the rule is getting an update.
The 4% rule says you should plan to spend 4% of your savings in the first year of retirement, and spend the same amount, adjusted for inflation, every year after that.
It caught on because it’s a simple formula to solve a complex problem: how to fund your retirement.
The 4% rule has drawn praise and pillory for years. Now, Bengen says it’s time for a revision: The 4% rule has become the 4.7% rule.
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The revision illustrates both the strength and weakness of the original 4% rule.
The rule endures as one of the best-known concepts in personal finance, brilliant in its simplicity.
“It’s lasted a long time because it’s memorable and it makes a very complex human problem feel a lot more manageable,” said Rob Williams, managing director of financial planning at Charles Schwab.
But some retirement experts say the rule is a little too simple. It dates to an era when many savers put half their money in stocks, half in bonds, the allocation Bengen used to formulate his original rule.
Nowadays, financial advisers often recommend that retirement savers diversify across a much longer list of “asset classes,” which might include several types of stocks and bonds, real estate, cash and cash-equivalents. And fewer investors park half their money in the bond market.
How the 4% rule became the 4.7% rule
The 4% rule began in 1994 as some math in a paper Bengen wrote for the Journal of Financial Planning. If retirees started out with that rate of spending, Bengen reasoned, their savings would last 30 years. (The actual figure was 4.15%. He rounded down.)
The rule took off, surprising even its author.
“It is surreal,” Bengen said. “I can’t believe that I’m still doing this, 30 years later.”
Bengen has continued to refine the rule, along with his own investment habits. Thirty years ago, his research focused on an equal mix of U.S. government bonds and large-company stocks. Today, he works with a broader investment portfolio, including stocks for large, medium and small companies, international stocks, bonds and Treasury bills.
“I’m up to seven asset classes now,” he said.
Bengen’s calculations now assume a slightly less conservative mix of 55% stocks, 40% bonds and 5% cash.
The broader portfolio, coupled with strong stock performance in recent years, changed the math for Bengen’s rule. For a new book, published in August, he posited the 4.7% rule.
“The primary reason for the change is that my research has gotten more sophisticated,” he said.
Bengen practices what he preaches, more or less. When he retired in 2013, he followed an updated version of his own rule, spending 4.5% of his savings in the first year.
“And that turned out to be too conservative,” he said. “Because the stock market has done so well, I’ve been able to adjust upwards.”
He’s now spending 4.9% a year.
Is the 4% rule still valid?
The 4% rule remains ubiquitous in financial planning. It is also the subject of endless critiques, in articles that question whether the rule still works or suggest it might no longer apply to most of us.
“The 4% was a general rule of thumb, but the reality is, people really have to look at the true price of what it costs to be them in retirement, or the them they want to be,” said Caleb Silver, editor-in-chief of the financial journalism site Investopedia.
Williams, of Schwab, said the 4% rule remains “a good place to start.” But a modern retirement plan, he said, is a living document. Retirees and their advisers can update spending targets every year, based on life changes, investment returns, inflation and other factors.
“Most folks that I talk to, their spending patterns over the 20 to 30 years they are retired are not static. They are dynamic,” said Douglas Ornstein, a director with TIAA Wealth Management.
One reason for the enduring popularity of the 4% rule is that it speaks to a paramount fear of Americans approaching retirement: outliving your money. A recent survey, from Allianz Life, suggests we fear running out of money more than death itself.
“As humans, when we have complicated challenges, like how much do we spend in retirement, that’s a scary question,” Williams said.
Many retirees follow the 4% rule. Some get it wrong.
Many retirees follow Bengen’s rule to the letter.
“I know some people do take it literally, because I get emails from people all over, every day,” Bengen said.
Not everyone gets the rule right. Some retirees mistakenly think the aim is to spend exactly 4% of your savings every year, Bengen said.
Here’s how the original rule actually works:
If you retire with $500,000 in savings, you spend $20,000 in the first year to supplement Social Security and any other income. If the inflation rate is 3%, you spend $20,600 in year two. And so on.
Herein lies another problem with the 4% rule: It seems to work better for the well-heeled.
The typical American in the 55-to-65 age range has about $185,000 in household retirement savings, according to the 2022 Survey of Consumer Finances.
Apply the 4% rule to $185,000 and you get $7,400 a year: Not much money.
“There are a lot of families out there who have no retirement savings at all,” said Amy Arnott, portfolio strategist at Morningstar.
Bengen’s rule is conservative. He formulated it to cover retirees in every economic scenario, with a spending rate that ensured savings would last through retirement.
The rule is based “on research that was trying to find the worst case among all retirees for the last 100 years,” Bengen said. “I think some retirees, a lot of retirees, should probably spend more.”