Busting the 4% Rule Myth

Discovering how the “Retirement Spending Hatchet” provides a problem for the 4 percent rule and why Derek Tharp suggests risk-based guardrails offer a more dynamic way to respond to risks in retirement.

The 4 percent rule gained steam through the mid 1990s as a way to ensure your retirement lasts throughout your retirement years. I sat down with Derek Tharp, Ph.D., CFP^®, CLU^®  assistant professor at the University of Southern Maine also known as the “Retirement Professor”, to discuss why he believes in a more dynamic approach to retirement spending. 

The 4% Rule: An Outdated Approach?

The 4% rule has long been a staple in retirement planning. It’s based on the idea that you can safely withdraw 4% of your retirement savings annually, adjusted for inflation, and not run out of money over a 30-year retirement. This rule was derived from historical data and designed as a conservative estimate to ensure retirees wouldn’t outlive their savings.

However, Derek argues that the 4% rule is more of an academic exercise than a practical tool for real-life retirement planning. He points out that it’s based on assumptions that don’t align with how retirees actually spend money. One of his key insights is what he and his coauthor, Justin Fitzpatrick, call the “retirement distribution hatchet.” This concept visualizes retirement spending patterns not as a smooth, linear drawdown but as front-loaded—heavier in the early years before Social Security and pensions kick in, creating a shape similar to a hatchet.

This observation is critical because it shows that many retirees’ spending needs are not constant but vary significantly over time. For instance, retirees might spend more in their early years when they’re still active, then spend less as they age, only to see spending increase again due to healthcare costs later in life. The 4% rule, with its focus on a steady, inflation-adjusted withdrawal rate, fails to account for these variations.

The Pitfalls of Probability of Success

Many financial advisors aim for plans that boast a high probability of success—often 90% or more—which essentially means that there’s a 90% chance that the retiree won’t run out of money.

However, Derek suggests that this focus can lead to overly conservative plans. A high probability of success might sound reassuring, but it often means that retirees are underspending—saving too much for a rainy day that might never come. To put it another way, a 95% probability of success actually implies that 94% of the time, you could have afforded to spend more.

This focus on probability of success can also create anxiety, especially during market downturns. Retirees might panic if they see their plan’s probability of success drop, leading them to make unnecessary adjustments. 

Risk-Based Guardrails: A More Flexible Approach

So, if the 4% rule and probability of success have limitations, what’s the alternative? Derek advocates for risk-based guardrails, a more flexible and responsive approach to retirement spending. This method allows retirees to set initial spending levels and then adjust them based on the performance of their investments, all within predefined “guardrails.”

For example, if your portfolio performs well and exceeds a certain threshold (the upper guardrail), you might increase your spending. Conversely, if the market underperforms and your portfolio drops to a lower threshold (the lower guardrail), you’d reduce your spending to stay on track. This approach provides a structured yet adaptable way to manage retirement income, focusing on actual financial health rather than arbitrary success probabilities.

One of the key benefits of this method is psychological. Knowing that you have a plan for both good and bad market conditions can reduce the anxiety that many retirees feel when they see market fluctuations. You’re not left wondering if you’re spending too much or too little—you have clear guidelines that tell you when to adjust your spending.

Planning for Real-Life Retirement

At the end of the day, retirement planning should be about making the most of your retirement years, not just ensuring you don’t run out of money. Derek’s approach of using risk-based guardrails is about finding a balance—allowing you to enjoy your retirement while being prepared for whatever the market throws your way.

It’s about planning for life’s uncertainties with flexibility and understanding that your spending needs will change over time. Rather than sticking rigidly to a rule developed decades ago, or chasing the highest probability of success, it’s about creating a retirement plan that evolves with you and your circumstances.

Your retirement goals should be at the forefront of your retirement decisions–if your goal is to avoid every risk. Instead of making your plan look good on paper, make your plan work for the life you want to live in retirement. The traditional 4% rule and the fixation on high probabilities of success might not serve you as well as a dynamic, responsive approach using risk-based guardrails.

Your retirement should be about enjoying life and having peace of mind, not just about making sure your plan is “successful” by rigid, outdated standards.

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Additional Links:

• “The Retirement Distribution “Hatchet”: Using Risk-Based Guardrails to Project Sustainable Cash Flows” – Justin Fitzpatrick & Derek Tharp
• “How Communicating Guardrails Withdrawal Strategies Can Improve Client Experience And Decrease Stress” – Derek Tharp
• “Reframing Monte Carlo Results to Increase Trust in Retirement Spending” – Derek Tharp
• Derek Tharp, “Retirement Professor” – www.retirementprof.com
• “Retirement Revealed” podcast episode with Justin Fitzpatrick

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