Retirement Withdrawal Strategies: Comparing the 4% Rule and Guardrails Approach

One of the biggest fears many retirees face isn’t death — it’s running out of money during retirement. And they’re not alone. According to the 2024 Annual Retirement Study from Allianz Life Insurance Company, two-thirds of Americans worry about outliving their savings.1
It’s a valid concern, but here’s the good news: with the right withdrawal strategy, you can design a roadmap for your retirement funds and help ensure your savings last a lifetime.
In this article, we’ll explore two common strategies (the 4% rule and retirement income guardrails), along with their pros and cons, so you and your wealth advisor can choose the one that’s best for your situation.

As you approach retirement, you may be wondering how much money you can safely withdraw from your investment portfolio without eventually running out of cash. Two key variables make it a difficult question to answer:

1. Future stock and bond market returns and economic indicators like inflation, interest rates, and taxes. These external factors will have a big impact on how much money can safely be withdrawn from your portfolio.
2. How long you’ll spend in retirement. Or in franker terms, how long will you live? The longer your lifespan, the longer you’ll need your nest egg to last. Of course, this is impossible to predict, which is why it’s important to create a retirement withdrawal plan that not only enables you to live a fulfilling lifestyle but also preserves your portfolio.

A Static Approach: The 4% Rule

For the past few decades, many retirees have used a withdrawal strategy referred to as the 4% rule. This strategy was introduced in 1994 by a financial planner named William Bengen, who based it on historical stock and bond market returns going back to the Great Depression and a long-term retirement horizon.

According to the strategy, retirees can withdraw 4% of their total portfolio each year for 30 years (adjusted for inflation) and have a 90% chance of not outliving their money. The rule assumes a retirement portfolio composed of 50% large-cap stocks and 50% intermediate-term Treasury bonds. 

The 4% rule has been popular for several reasons, including its simplicity. Retirees withdraw 4% of their portfolio balance annually, regardless of market performance or their personal circumstances. 

However, its simplicity is also one of the biggest potential drawbacks of the 4% rule, since it doesn’t account for changing market conditions or retirees’ specific financial needs. Moreover, the average life expectancy for Americans has risen over the past three decades, which makes it more likely that retirees could spend longer than they realize in retirement.2 (Needless to say, that’s not a bad thing, but it’s still a tricky variable nonetheless)

High levels of market volatility and the uncertain economic environment are other potential drawbacks to the 4% rule. In addition, retirees may end up with higher living expenses than they expected, especially when it comes to health care and long-term care expenses.

A recent article in The Wall Street Journal states that the 4% rule could lead to “catastrophic outcomes” for retirees and put them “at risk of financial ruin.”3 One study cited by the article suggests that retirees withdraw just 2.3% of their total portfolio each year, or nearly half the 4% touted by Bengen. 

Meanwhile, a report by Morningstar recommended a 3.7% withdrawal rate for retirees due to predictions of lower stock and bond returns in the future after years of outperformance.4

These recent studies reflect the challenges of predicting the future and adapting to unforeseen variables. In other words, the 4% rule (or 2.3%, 3.7%, or any general guideline) is a useful starting point, but it’s just that: a starting point. It’s far more important to adopt a withdrawal strategy that aligns with your unique and evolving circumstances.

An Alternate Strategy: Retirement Income Guardrails

Fortunately, there’s another retirement withdrawal planning strategy that avoids some of the drawbacks of the 4% rule. Retirement income guardrails, also known as dynamic withdrawals, offer more flexibility to accommodate real-world market performance and the value of your portfolio.

The retirement income guardrails strategy, which was introduced by a financial planner named Jonathan Guyton and a professor named William Klinger, is designed to maximize your monthly income in retirement without jeopardizing your portfolio’s long-term value when financial markets decline.

It’s not only more flexible than the 4% rule but also gives you an idea of what kind of spending changes you’ll need to make if a market downturn occurs, which can reduce financial stress and give you more peace of mind.

In an interview with Morningstar, Guyton explains retirement income guardrails with a relatable analogy: “If you think about driving your car down a road, you hit a guardrail, it does two things. It puts a ding in your car, and it changes your momentum so that instead of the momentum pushing you toward the edge of the road, it now starts to shift you back toward the middle where it’s safe.”5

With retirement income guardrails, instead of withdrawing a fixed percentage of your portfolio’s value annually, you set upper and lower “guardrails” based on your target withdrawal rate. This initial rate should factor in your household budget and lifestyle preferences, but, keep in mind, it isn’t set in stone.

• Upper guardrails: If your portfolio performs better than you expected, you can withdraw more money than you originally planned and increase your discretionary spending. Maybe you could use the extra money to splurge on a dream vacation, join a country club, or treat yourself and your spouse to a few extra date nights each month.
• Lower guardrails: If the investment markets dip and your portfolio underperforms, you would withdraw less money than you originally planned and lower your spending. This will probably require tightening your budget a little — for example, by taking a cheaper vacation or eating out less often. But if conditions change later, you can adjust your withdrawals again to reflect this.

Historically, the financial markets generate positive returns about 7 out of every 10 years.6 Based on this data, the guardrails strategy should lead to more years of comfortable spending than years when you need to cut back.

Setting Your Guardrails

A common guardrail is 20% above and below your target withdrawal rate. So, if your target rate is 5%, your lower guardrail would be 4% and your upper guardrail would be 6%. Here are two examples that illustrate how retirement income guardrails could work:

Let’s say you have a $1.2 million retirement portfolio and your target withdrawal rate is 5%. This translates to $60,000 per year, or $5,000 per month. If the markets fell last year and your portfolio’s value dropped to $950,000, your target withdrawal of $60,000 per year would represent a 6.3% withdrawal rate, which is higher than your upper guardrail of 6%. 

To stay within your guardrail, you’d need to reduce your annual withdrawal to $57,000, or $4,750 per month.

Now let’s assume the markets were up last year and your portfolio’s value rose to $1.5 million. Your target withdrawal of $60,000 per year now represents a 4% withdrawal rate. You could increase your annual withdrawal to $90,000, or $7,500 per month, if you wanted, and still stay within your upper guardrail.

It’s important to note that reducing your withdrawal rate by a certain percentage doesn’t necessarily mean you have to reduce your spending by the same amount, assuming you have other sources of income like Social Security. Plus, withdrawing less money from traditional retirement accounts can help lower your income taxes.

Let’s walk through a simplified example. Suppose you withdraw $50,000 per year from your retirement portfolio, receive $30,000 per year in Social Security benefits, and pay $10,000 per year in taxes. During a market downturn, you hit your lower guardrail and need to lower your annual withdrawal by 10% to $45,000. 

Withdrawing $5,000 less from your portfolio could lower your taxes from $10,000 to $8,500. This would lower your net income from $70,000 ($50,000 + $30,000 – $10,000) to $66,500 ($45,000 + $30,000 – $8,500) — a reduction of just $3,500, compared to a withdrawal reduction of $5,000.

Now that you have an idea of how retirement income guardrails work, you can follow these five steps to establish your own guardrails and help ensure your retirement nest egg lasts as long as you live:

1. Set your target withdrawal rate. This rate should allow you to withdraw enough money to live your desired retirement lifestyle. Base your target withdrawal rate on your household budget, including both fixed and discretionary expenses.
2. Set your upper and lower guardrails. Many people set guardrails of 20% above and below the target withdrawal rate. A financial advisor can help you set the right guardrails based on your circumstances.
3. Monitor portfolio performance. Keep an eye on investment performance to see whether your portfolio’s value is approaching your upper or lower guardrails. This might include a quarterly or biannual portfolio review with your financial advisor.
4. Adjust your withdrawal rate, if necessary. If performance remains within your guardrails, you can relax, no action is necessary. But if performance exceeds your upper or lower guardrails, adjust your withdrawal rate to reflect performance, as described in the examples above.
5. Reassess your guardrails periodically. Take a fresh look at your guardrails every few years or when major life changes occur, like a marriage or divorce, arrival of grandchildren, or health changes. These life events might require you to change your guardrail strategy.

Despite the benefits, the retirement income guardrails strategy isn’t right for everyone. It might be a good strategy for you if you answer yes to one or more of these questions:

• You want the flexibility to be able to withdraw and spend more money when your portfolio outperforms.
• You’re comfortable making adjustments to your lifestyle and cutting back on spending when your portfolio dips in value.
• You prefer a more customized approach to retirement income planning that considers your unique circumstances and real-world investment performance, versus a static, one-size-fits-all approach.

To summarize, the 4% rule is, at best, a static starting point. On the other hand, retirement income guardrails are dynamic — they offer more flexibility to adjust your withdrawal rate based on real-world market performance and help to preserve your portfolio for the long term.

If you have more questions about sustainable retirement income guardrails or are ready to take the next step, Pine Grove is here to help. Schedule a free consultation with one of our wealth advisors today to build a retirement withdrawal strategy that’s right for you.

Sources

1. Allianz Life Insurance Company, “Nearly 2 in 3 Americans Worry More about Running Out of Money than Death”
2. Census data, “Living Longer: Historical and Projected Life Expectancy in the United States,1960 to 2060”
3. The Wall Street Journal, “A Time-Honored Strategy Puts Your Retirement at Risk of Financial Ruin”
4. Morningstar, “Six Retirement Withdrawal Strategies That Stretch Savings”
5. Morningstar, “How Do Flexible Retirement Withdrawals Work in Practice?”
6. S&P 500 data