Use 4% rule cautiously

Those approaching retirement and wondering how much they'll safely be able to withdraw from their nest egg each year will likely run across the famous “4% rule.” It can be very handy, but it has some significant flaws.

The rule says to withdraw 4% of your nest egg in your first year of retirement and then adjust each subsequent year's withdrawal for inflation. So if you've socked away $600,000 by retirement, you'd take out $24,000 in Year 1. And if inflation averaged 3% that year, you'd take out 103% of that amount the next year — $24,720. Some back-testing has suggested that following the rule is likely to make your nest egg last at least 30 years.

One reason the rule is problematic is because it doesn't consider the economic environment. Inflation averaged a whopping 8% in 2022. If a retiree boosted their withdrawal by 8% this year, when the economy isn't firing on all cylinders and a threat of recession persists, they could shrink their nest egg too much. Some recommend withdrawing less when the economy is struggling and more when it's booming.

Here's another consideration: The rule was devised by testing, over time, portfolios with an asset allocation split between stocks and bonds. If your own portfolio is all in stocks or bonds, or has a different allocation, your results will probably vary considerably.

Also, it's great if your nest egg lasts 30 years, but what if you retire at age 60 and live to age 96? That's 36 years of retirement. The way we spend money throughout retirement varies, too, suggesting that a more flexible withdrawal strategy might be better. For example, many retirees spend a lot on travel and fun in their early golden years, then taper their spending, then ramp it up again for growing health care expenses in their later years.

Go ahead and use the 4% rule as a rough guide, but consider consulting a financial adviser or planner to help determine what strategy and withdrawal rates are best for you.