Retirement guidance from the original 4% rule author has been updated: Learn about the author's current retirement advice
In a 1994 Journal of Financial Planning paper, William Bengen introduced the 4 percent rule, a formula designed to help retirees determine a safe withdrawal rate from their portfolios each year, adjusted for inflation, without depleting it over a 30-year period.
According to Bengen, inflation is "probably the most important factor of all" when determining a retirement withdrawal strategy. It attacks purchasing power relentlessly, making it crucial to account for its impact when planning for late-life out-of-pocket spending on healthcare and other expenses.
The current recommended safe withdrawal rate according to Bengen is approximately 4% per year. However, the original math behind the 4 percent rule came out to 4.15 percent, but it was rounded down to 4 percent.
One way to plan for these expenses is to pre-fund a medical reserve with T-bills or a short ladder of Treasury Inflation-Protected Securities (TIPS). Another option is to gradually contribute to a high-yield savings account specifically earmarked for health care costs.
Bengen also suggests using simple annuities to steady retirement income and taking evenly spaced withdrawals throughout the year to smooth income and avoid market-timing risks. He recommends annual rebalancing of portfolios.
In his new model portfolio, Bengen expanded to include U.S. large-cap stocks, U.S. mid-cap stocks, U.S. small-cap stocks, U.S. micro-cap stocks, international stocks, intermediate-term U.S. government bonds, and U.S. Treasury bills. He challenges the traditional advice to scale back on stocks before retirement, preferring to stay 100 percent invested in equities until five years before retirement.
Bengen's withdrawal strategy was never designed to dictate how retirees spend, but rather focuses on the withdrawal side - taking money out. He believes a set-it-and-forget-it approach is dangerous, and retirees should revisit their withdrawal strategy every couple of years.
Interestingly, Bengen sees a small role for alternative assets like Bitcoin (1 percent in his own portfolio). He also suggests retirees should build a separate, detailed budget that includes planned big-ticket expenses.
In recent years, Bengen has revised the figure. In 2006, he revised the figure to 4.5 percent, and now identifies 4.7 percent as the worst-case starting point. He even goes as far as saying that most retirees can comfortably take 5.25 to 5.5 percent out without worrying about running out of money.
Bengen's updated method is likened to following a cookbook, with specific "ingredients" such as taxable or tax-deferred accounts, leaving money to heirs, and when to claim Social Security. It's a practical approach that offers retirees a clear path for managing their finances during their golden years.
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