Is the 4% rule still reliable as a safe withdrawal strategy?

You’ve worked hard to build up a decent pension pot, and now at retirement, you’re wondering how much income you should take out to give yourself a comfortable lifestyle.

Withdraw too much, and you risk depleting your nest egg and surviving on just the state pension.

Withdraw too little, and you may have foregone luxuries in retirement. Maybe you could have taken that cruise, after all. Sure, you can pass the remaining pension pot on to your loved ones, but maybe that wasn’t your plan - and it could be hit with inheritance tax (IHT) in the future.

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Nobel Prize-winner Bill Sharpe once called the process of turning retirement savings into income the “nastiest, hardest problem in finance”.

Whether it’s a self-invested personal pension (SIPP) or a workplace defined contribution (DC) scheme, the issue has prompted financial advisers and data analysts to create rules that savers can use to ensure their pensions last as long as they do.

Perhaps the most famous is Bill Bengen’s 4% rule. Developed in the 1990s, American financial planner Bengen used the rule to show that retirees could safely withdraw 4% of their pension pot in their first year, increasing the amount by inflation each following year.

However, he recently said that retirees could safely withdraw 4.7% of their portfolio in the first year of retirement, up from 4%, while still ensuring their savings last for 30 years. Meanwhile, in 2021, Morningstar suggested 3.3% was a more realistic rule of thumb. 

Let’s examine how a safe withdrawal rule works, and the pros and cons.

The 4% (or is it 4.7%?) rule

Bengen’s rule is based on historical data from 1926 to 1976, and assumes the pension pot is invested 50% in shares and 50% in government bonds.

The idea is that 4% can be taken as income during the first year of retirement. That annual income should rise each successive year by the rate of inflation, irrespective of any fluctuations in the pot’s value.

He modelled how his rule would have worked for savers who retired in any year from 1926 onwards (his original work was published in 1994), and found in all cases the savers’ money would have lasted at least 30 years.

This has now been upgraded to a 4.7% rule, but Bengen thinks this is still ultra-conservative and most people would have lots of money left over, according to an article on US website MarketWatch in May.

The reason for the change is that it’s based on a more diversified portfolio, containing smaller company shares, international shares and different bond types.

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David Gibb, a chartered financial planner at Quilter Cheviot, says there are benefits to Bengen’s rule, as “it helps people visualise how much they might sustainably take from their pot each year without running out of money”.

However, there are also downsides. For a start, the original calculations use the S&P 500 and US inflation figures (the updated diversified portfolio is also heavily skewed to American shares).

This may not be much use for UK investors. Doug Brodie, CEO of Chancery Lane Income Planners, notes: “US RPI is not the same as UK RPI, which was 3.06% per year from 1995 to 2024, compared to 2.52% in the US. This means the 4% rule was using an inflation figure that is 17% lower than the UK, and an investment return figure of 10.7% in the US versus 8% in the UK.”

Life expectancy is also different today compared to several decades ago. 

Gibb adds that using a percentage-based rule “risks becoming a crutch rather than a guide, and it doesn’t account for major variables such as investment performance or changing personal circumstances”.

Alternative income strategies

Beyond the 4% rule, there are other retirement income strategies, such as:

• Natural yield 
• Total return
• Essential vs discretionary (“flooring strategy”)

With the natural yield approach, rather than selling your investments to fund retirement spending, you simply live off the income these investments produce. This could be dividends from shares, coupons paid on bonds or interest on cash.

This leaves the capital intact to pass on to loved ones, or to start withdrawing if you live longer than expected or need the money later for, say, care fees.

However, a drawback is that the yield will fluctuate each year. So, if you have a £500,000 pension pot and you need an annual budget of £25,000, that’s great if you get a natural yield of 5%. But it becomes a problem if the yield falls to, say, 2%.

Brodie highlights the total return approach as another strategy that DIY investors can employ. “Total return means running an investment portfolio and selling assets every year to provide the cash to be paid out. Natural yield involves using income-producing assets that pay income every year automatically, so you never have to sell any assets. 

“It’s like having a buy-to-let portfolio of student studios - you can sell one occasionally to generate cash to live on, or live on the rent and never sell anything,” he explains.

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The flooring strategy prioritises spending goals between needs and wants. Money for essential expenses comes from a secure income source, such as a final salary pension or state pension. While your “wants” – discretionary expenses – can have more risk associated with them, and therefore be funded by pension drawdown.

How to personalise your withdrawal strategy

Different strategies will work for different retirees, but the important point is to make sure you personalise yours.

You’ll likely have other income streams, such as the state pension and perhaps a final salary pension, which will affect how much you need to withdraw from your SIPP.

You may also want to leave your partner or other loved ones an inheritance, and your pension pot could be part of that.

Carolyn Jones, retirement director at Scottish Widows, comments: “The reality of retirement today has changed significantly, with many choosing to partially retire, delay retirement to work for longer or even start a new business at an older age. With this in mind, it’s important that any withdrawal plan fully reflects a person’s circumstances and lifestyle choices.”

According to Gibb, rather than fixating on something like the 4% rule, investors should base their income plan on their “spending needs, asset mix, health status, and any guaranteed sources of income like the state pension”, adding that “reviewing that plan at least annually is crucial, especially during periods of market volatility”.

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If you do want to use something like the 4% rule, you may wish to use a lower percentage in poor market conditions, as this offers more sustainability - while a higher one may be better for wealthier retirees with other income sources or shorter expected time horizons.

However, Brodie warns that “if you run down the portfolio for any reason, there’s only two ways back: either cut spending or add more money to the pot”. He adds that if retirees want a simple solution, the best bet could be an annuity. 

According to Steve Webb, partner at pension consultants LCP, one tactic could be to use drawdown for a fixed period, and then at a set age, say 80, an annuity is bought, which pays out for the rest of your life. 

“This has the advantage that you deal with the longevity point in later retirement, but also the ‘sustainability’ issue becomes a lot easier to solve when you know how long the pot needs to last for,” he comments. 

Make sure you budget for extra costs early in retirement, as research shows people often “front load” their spending when they stop work. 

“This could be things like the ‘trip of a lifetime’ or gifts to the next generation - and these tend to imply spending more earlier and less later, perhaps when you are less mobile and less able to get out and about,” says Webb.

Changing behaviour ahead of pensions becoming liable for IHT in 2027

Some retirees are starting to spend more of their pensions due to them becoming liable for IHT from April 2027. Previously they may have left them intact or only withdrawn a small amount - prioritising other income sources such as ISAs for their retirement spending - so they could pass them to loved ones free of IHT.

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If you had been using the 4% rule, you may consider increasing it slightly, if you’re now aiming to use up more of your pension pot before you die, and minimise any cut the taxman takes.

“We’re starting to see some retirees spending more of their pension rather than leaving it untouched as a tax-free legacy,” says Gibb.

“This may lead some people to increase their withdrawal rate or look to use more of their tax-free cash earlier. However, it’s important that any decision is rooted in a clear plan, not driven by fear of tax changes.”