Understanding the 4% Rule for Early Retirement

The 4% rule has become something of a sacred number in retirement planning circles. Mention it at any FIRE meetup, and heads nod in recognition. But where did this figure come from? And more importantly-does it actually work?

The Trinity Study: Where It All Started

In 1998, three professors from Trinity University published research that would reshape how people think about retirement withdrawals. Philip Cooley, Carl Hubbard, and Daniel Walz analyzed historical market data spanning 1926 to 1995. Their question was straightforward: what withdrawal rate gives retirees the best chance of not running out of money?

Their findings pointed to 4% as a sweet spot.

A retiree withdrawing 4% of their initial portfolio value annually, adjusted for inflation, had roughly a 95% chance of their money lasting 30 years. The portfolio mix that performed best? A 50/50 or 75/25 split between stocks and bonds.

The math works like this: someone with $1 million withdraws $40,000 in year one. Year two, they adjust that $40,000 for inflation-say 3%-making the withdrawal $41,200. This continues regardless of what the market does.

Why 4% Works (Most of the Time)

Stock markets have historically returned around 7% annually after inflation. Bonds add stability while generating 2-3% real returns. A blended portfolio earning 5-6% can theoretically sustain 4% withdrawals indefinitely.

But averages lie.

Sequence of returns risk is the wrench in the gears. A retiree who starts withdrawing during a market crash faces a dramatically different outcome than one who begins during a bull run. Wade Pfau’s research at the American College of Financial Services found that the first decade of retirement essentially determines success or failure. Poor early returns combined with ongoing withdrawals create a hole that subsequent gains struggle to fill.

Consider two scenarios with identical average returns:

Retiree A experiences -15%, -10%, +8%, +12%, +20% in their first five years. Retiree B sees +20%, +12%, +8%, -10%, -15% in their first five years.

Same average - wildly different outcomes. Retiree A’s portfolio takes a beating while they’re still withdrawing from a shrinking base. Retiree B builds a cushion before the downturn hits.

The Rule’s Limitations for Early Retirees

Here’s where things get complicated for the FIRE crowd.

The Trinity Study examined 30-year retirement periods. Someone retiring at 65 and planning for age 95 fits this model. But a 35-year-old pursuing early retirement? That’s potentially 50-60 years of withdrawals. The math changes substantially.

Michael Kitces, a financial planning researcher, has noted that extending the time horizon to 40 or 50 years drops success rates noticeably. A 4% withdrawal over 50 years historically succeeded about 85% of the time-still decent, but that 15% failure rate represents running out of money in your 80s.

EarlyRetirementNow, a popular FIRE blog run by a former economist, conducted extensive simulations using data back to 1871. Their conclusion - for 60-year retirements, a 3. 25-3. 5% withdrawal rate provides more reasonable safety margins.

That difference matters. On a $1 million portfolio:

• 4% = $40,000/year

That’s $7,500 annually, requiring either more savings before retirement or a leaner lifestyle after.

Factors the Original Study Didn’t Consider

The Trinity research made assumptions that don’t reflect everyone’s reality.

Investment fees weren’t factored heavily into the analysis. Someone paying 1% annually in fund expenses effectively reduces their safe withdrawal rate. Low-cost index funds charging 0 - 03-0. 10% make the 4% rule more viable than actively managed funds charging 1%+.

Taxes complicate withdrawals significantly. A $40,000 withdrawal from a traditional IRA triggers income tax. The same amount from a Roth IRA doesn’t. Tax-efficient withdrawal sequencing-pulling from taxable accounts first, then tax-deferred, then Roth-can extend portfolio longevity.

Social Security wasn’t part of the equation. Most retirees will eventually receive some benefit, reducing the portfolio’s burden. A FIRE retiree at 35 won’t see Social Security for 27+ years, but it does eventually arrive.

Healthcare costs present perhaps the biggest wildcard. Early retirees in the United States face a coverage gap between leaving employer insurance and Medicare eligibility at 65. ACA marketplace plans can run $500-1,500 monthly for a family. That expense alone might require adjusting the withdrawal rate upward during pre-Medicare years.

Practical Modifications That Improve Odds

Rigid adherence to any rule ignores human adaptability. Several approaches increase success rates beyond the base 4% framework.

Variable withdrawal strategies adjust spending based on market conditions. The Guyton-Klinger guardrails method, for instance, increases or decreases withdrawals when portfolio values cross certain thresholds. If the portfolio drops 20%, spending gets cut 10%. This flexibility dramatically improves 50-year success rates.

The bucket approach separates money into time-based segments. Bucket one holds 2-3 years of expenses in cash and short-term bonds. Bucket two covers years 3-10 in intermediate bonds. Bucket three holds stocks for year 10 and beyond. During downturns, retirees draw from buckets one and two while stocks recover.

Part-time income provides a buffer that pure withdrawal strategies lack. Even $10,000-15,000 annually from consulting, teaching, or freelance work reduces portfolio pressure substantially. Many early retirees find they want some productive engagement anyway.

Geographic arbitrage stretches dollars further. A 4% withdrawal provides $40,000 in both Manhattan and Medellín, but lifestyle quality differs enormously. Some FIRE adherents split time between high-cost home bases and lower-cost locations abroad.

What Recent Research Suggests

The debate around safe withdrawal rates continues evolving.

A 2021 study by Morningstar researchers suggested that given current low bond yields and elevated stock valuations, a 3. 3% withdrawal rate might be more appropriate for new retirees. This sparked considerable discussion-and pushback-in financial planning circles.

Bill Bengen, the financial planner who actually proposed the 4% rule before the Trinity Study formalized it, has updated his own views. In recent years, he’s suggested that incorporating small-cap value stocks into the portfolio mix could support withdrawal rates as high as 4. 5%.

The truth probably lands somewhere in between. Historical data provides guidance, not guarantees. Future returns might exceed historical averages. They might fall short - nobody knows.

Making the Decision Personal

The 4% rule offers a starting point, not a final answer.

Someone with a pension covering basic expenses can afford a higher withdrawal rate from their portfolio-they’ve got a floor. A person with no guaranteed income and high fixed costs needs more cushion.

Risk tolerance matters too. The psychologically comfortable number might differ from the mathematically optimal one. Running Monte Carlo simulations showing 92% success sounds great until you’re lying awake at 3 AM wondering if you’re in the 8%.

Flexibility remains the ultimate hedge. The retiree willing to cut spending 10-15% during prolonged downturns, pick up occasional work, or relocate if necessary has options that rigid withdrawal plans don’t capture.

Perhaps the most honest assessment: the 4% rule works reasonably well for traditional 30-year retirements with balanced portfolios and moderate flexibility. For early retirees planning 40-50+ year horizons, something closer to 3. 5% provides more margin for error. And anyone using these guidelines should build in adaptability-because decades-long financial plans never survive contact with reality completely intact.

The number on a spreadsheet matters less than the willingness to adjust when circumstances demand it.