After building your retirement savings, you must decide how much to withdraw each year without spending down your assets too quickly.
One commonly cited guideline is the “4% withdrawal rule.” Its simple calculation can help you estimate a rough retirement savings target, but it is not an absolute rule that guarantees safety for everyone.
Before applying the 4% figure, review— How to Determine the Order of Retirement Withdrawals—and understand the assumptions behind the rule.
What Is the 4% Withdrawal Rule?
The 4% withdrawal rule suggests withdrawing 4% of your investment portfolio in the first year of retirement and adjusting that first-year amount for inflation in each following year.
The rule is based on financial planner William Bengen’s 1994 study, “Determining Withdrawal Rates Using Historical Data.”
Bengen analyzed different retirement starting dates and portfolio allocations using historical returns from U.S. stocks and intermediate-term government bonds. The central question was how much a retiree could initially withdraw, adjust for inflation each year, and still make the portfolio last for at least 30 years.
As the research became widely known, the strategy became commonly referred to as the 4% rule.
How to Calculate the 4% Rule Correctly
The 4% rule does not mean withdrawing 4% of your remaining portfolio every year.
Calculate the first-year withdrawal as follows.
First-year withdrawal = Investment portfolio at retirement × 4%
For example, if you have KRW 500 million in investment assets when you retire, calculate the first-year withdrawal as follows.
KRW 500 million × 4% = KRW 20 million per year
Dividing this amount by 12 gives an average monthly withdrawal of approximately KRW 1.67 million before taxes and fees.
Beginning in the second year, you do not recalculate 4% of the remaining portfolio. Instead, you adjust the first-year withdrawal amount for inflation.
If you withdrew KRW 20 million in the first year and inflation was 3%, calculate the second-year withdrawal as follows.
KRW 20 million × 1.03 = KRW 20.6 million
This method is intended to preserve the purchasing power of a retiree’s living expenses. However, it may require you to keep increasing withdrawals even when asset prices fall sharply or inflation rises rapidly.
Why Is It Also Called the Rule of 25?
The 4% rule can also be expressed as a guideline suggesting that you need approximately 25 times the annual amount your investments must provide.
Target retirement portfolio = Annual living-expense shortfall funded by investments × 25
This is because 25 is the reciprocal of 4%.
For example, if your annual retirement expenses are KRW 30 million and public and employer pensions provide KRW 18 million, your investment portfolio must provide the remaining KRW 12 million each year.
KRW 12 million × 25 = KRW 300 million
This calculation uses the KRW 12 million shortfall remaining after pension income, not the full KRW 30 million of annual living expenses.
Start with— How to Organize Your Retirement Income Sources—to separate stable income from the remaining living-expense gap.
Assumptions Behind the 4% Rule
Before applying the 4% rule, understand that it was developed using the following assumptions.
- It assumes a retirement period of approximately 30 years.
- It is based on historical returns from U.S. stocks and bonds.
- It assumes a portfolio containing a mixture of stocks and bonds.
- It adjusts the first-year withdrawal amount for inflation each year.
- It assumes that the portfolio is regularly rebalanced to maintain its target asset allocation.
- It may not fully reflect how taxes and investment fees reduce the amount available for living expenses.
- It attempts to maintain consistent inflation-adjusted spending regardless of market conditions.
If your circumstances differ from these assumptions, the sustainability of a 4% withdrawal rate may also differ.
7 Limitations to Check Before Using the Rule
1. The Research Is Based on Historical U.S. Markets
The 4% rule was developed using historical returns from U.S. stocks and bonds.
Market returns, inflation, exchange rates, and tax systems in other countries may differ from those in the United States. The same results are not guaranteed if you live outside the United States or invest in different types of assets.
2. It Assumes a Retirement Period of Approximately 30 Years
The same withdrawal rate may not be appropriate for someone retiring at 55 and planning for more than 40 years and someone retiring at 70.
A longer retirement means your assets must last longer, so a more conservative plan than the standard 4% rule may be necessary.
3. It Is Vulnerable to Market Declines Early in Retirement
If markets fall sharply during the first few years of retirement, maintaining the same spending level may force you to sell more investment assets.
Once the principal has been reduced early in retirement, it may not generate enough growth even if the market later recovers. This is known as sequence-of-returns risk.
4. Actual Living Expenses Do Not Move Exactly with Inflation
Healthcare, housing, and long-term care costs may rise faster than overall inflation. On the other hand, travel and leisure expenses may be reduced when necessary.
Adjusting every expense by a single inflation rate may create a gap between the plan and your actual spending.
5. Taxes and Fees Must Be Included
Even if you withdraw KRW 20 million from your investments, the amount available to spend may be lower after taxes and transaction costs.
Because taxes and fees vary by account type, investment product, and country of residence, calculations should be based on the after-tax amount available for living expenses.
6. It Assumes a Consistent Level of Spending
In real life, expenses may rise sharply in certain years because of a vehicle purchase, home repairs, medical costs, or financial support for family members.
Conversely, reducing discretionary spending during a market decline may lower the risk of depleting your assets. A flexible withdrawal plan may therefore be more appropriate than withdrawing a fixed inflation-adjusted amount every year.
7. It Does Not Account for Other Income or Assets You Want to Leave Behind
The 4% rule does not automatically consider whether you want to leave assets for inheritance or charitable giving.
The role of an investment portfolio will also differ for someone with substantial public pension, employer pension, rental, or employment income. If investments must provide most of your living expenses, a more cautious withdrawal plan may be necessary.
5 Steps for Using the 4% Rule
Step 1: Calculate Your Annual Retirement Expenses
Use your current spending as a starting point and separate essential retirement expenses from discretionary expenses.
If you have not set your target amount yet, begin with— How to Calculate the Retirement Savings You Need—before proceeding.
Step 2: Subtract Stable Annual Income
Subtract public pensions, employer pensions, and other stable after-tax income from your annual living expenses.
The amount remaining is the annual shortfall your investment portfolio must provide.
Step 3: Multiply the Annual Shortfall by 25
Multiplying the annual shortfall by 25 gives you a rough target portfolio based on the 4% rule.
However, this figure is not a guaranteed target. It is only a starting point for reviewing your retirement plan.
Step 4: Adjust for Your Personal Circumstances
Consider your expected retirement period, health, taxes, fees, portfolio allocation, inflation, and estate goals when deciding whether 4% is appropriate for you.
You should also consider whether you can reduce spending during a market decline and whether you have a separate emergency fund.
Step 5: Review Withdrawals and Assets Every Year
Rather than following the same withdrawal method automatically every year, review changes in your actual expenses, pension income, and investment assets.
If your assets decline faster than expected, adjust discretionary spending or withdrawals. Even if the portfolio remains stable, continue reviewing taxes and asset allocation.
Common Misunderstandings About the 4% Rule
The first misunderstanding is that you should withdraw 4% of the remaining portfolio every year. Under the traditional rule, you set the withdrawal amount in the first year and then adjust that amount for inflation.
The second misunderstanding is that the portfolio is expected to earn a 4% return every year. The 4% figure is the initial withdrawal rate, not an expected investment return.
The third misunderstanding is that withdrawing 4% guarantees your assets will last for life. The rule is based on specific historical data and assumptions and does not guarantee future results.
The fourth misunderstanding is applying the 4% rate to every asset you own. Assets that cannot easily be converted into money for living expenses, such as your primary residence or vehicle, should not be treated in the same way as an investment portfolio.
The fifth misunderstanding is failing to account for taxes and fees. Your calculations should be based on the amount actually available for living expenses.
Checklist Before Applying the 4% Rule
- Have you calculated the annual shortfall your investments must provide?
- Have you applied the 4% rule to the income shortfall rather than your total living expenses?
- Have you considered the possibility that your retirement may last longer than 30 years?
- Have you accounted for taxes and investment fees?
- Do you have discretionary expenses that can be reduced during a market decline?
- Have you prepared separate funds for emergencies and healthcare costs?
- Do you want or need to leave assets behind?
- Can you review and adjust your withdrawal amount every year?
The 4% Rule Is a Starting Point, Not a Final Answer
The 4% withdrawal rule is a useful guideline that turns a complex retirement question into a simple starting calculation.
However, it was developed using historical U.S. market data, an approximately 30-year retirement period, and a portfolio containing both stocks and bonds. For this reason, you should not automatically apply a 4% withdrawal rate to your own assets.
First calculate your retirement income shortfall, then account for taxes, fees, the length of retirement, and your ability to adjust spending. After that, review your living expenses and assets every year and adjust your withdrawals when necessary.
In the next article, we will examine how inflation affects retirement living expenses and the purchasing power of retirement savings.
※ This article is provided for general financial education. It does not guarantee the safety of any withdrawal rate or recommend a specific investment or tax strategy for an individual.
References
William P. Bengen, Determining Withdrawal Rates Using Historical Data
Financial Planning Association, Is the 4 Percent Rule Too Low or Too High?
Investor.gov, Is It Time to Rebalance Your Investment Portfolio?