Retirement this year? Why relying on the 4% rule might cost you and what to do instead?

Retirees may want to plan for modest returns in the future and adjust the withdrawal strategy of their retirement funds, according to Morningstar.

According to Morningstar projections from earlier this year, retirees could safely withdraw 3.7% from their nest egg in 2025 as a starting point, which is well below the 4% recommended by the rule of thumb.

The 4% rule suggests building a retirement plan in such a way that if you withdraw 4% of your retirement savings money in the first year, and then adjust the withdrawal amounts for inflation, you won’t run out of money for a 30-year retirement period.

Running out of money in retirement is a major concern for many Americans, and experts say having a withdrawal strategy for your nest egg is just as important as saving for retirement.

For many, a good starting point is a general rule such as the 4% rule, but it may not necessarily be right for everyone. Here’s what experts recommend doing instead.

Why get rid of the 4% rule?

Those who peg their initial withdrawal rate at 3.7% in 2025 — while adjusting annually for inflation after that — will have a 90% chance of not running out of money during a 30-year retirement, according to Morningstar. This withdrawal rate was based on portfolios that allocated 20% to 50% to stocks and the rest in bonds and cash.

At the end of 2023, Morningstar recommended a top withdrawal rate of 4%, so why should investors be more conservative about the withdrawal rate now?

Researchers expect that higher equity valuations will reduce future returns and that interest rate cuts by the Federal Reserve will reduce returns.

“The decline in the withdrawal ratio compared to 2023 is largely due to higher equity valuations and lower fixed income returns, leading to lower return assumptions for stocks, bonds, and cash over the next 30 years,” the researchers wrote.

Analysts at Vanguard also warned of lower future stock market returns for long-term investors.

Consider a flexible withdrawal strategy

Some retirees can benefit from a more dynamic approach to withdrawal by taking into account factors such as market performance or age.

Ted Brown, senior vice president and financial advisor at Wealth Enhancement Group, said a fixed withdrawal rate can be a useful starting point, but his clients often adjust their withdrawal rates based on their needs or the market.

“There will be years where you’ll withdraw 6%, 7%, or 8% because your child gets married or you buy a house,” Brown said. “But then there will also be years where you make a huge return, like this year, and if you don’t adjust your withdrawal rate, you’re probably taking out 2 or 3%.”

While a fixed withdrawal rate can ensure consistent annual cash flow, one of its biggest downsides is that your money can outlast retirement. This is great news if you want to leave the money to your heirs, but you could have enjoyed that money, too, if you had withdrawn more.

A flexible strategy like the hurdles approach — where you can adjust your withdrawal rate up or down based on market performance — will mean more volatility in your spending from year to year and less money left over.

Rely on Social Security and bond ladders to increase your money

Most retirees receive guaranteed income as Social Security, but Morningstar points out that annuities and even Treasury Inflation-Protected Securities (TIPS) are types of guaranteed income that, when used strategically, can help boost people’s spending power in retirement.

The decision of when to collect Social Security can have a significant impact on your standard of living in retirement. While delaying taking Social Security benefits past full retirement age (which is between 66 and 67 years old) may result in larger monthly checks, it may not be an option for some people who need that money sooner. Even for those who expect to live longer, delaying may not be beneficial — if you have to tap other retirement accounts before you turn 70, that could result in a smaller nest egg in the future.

30-year ladder TIPs with staggered maturity periods could be another option for regular income, according to Morningstar. With ladder TIPs, investors will use maturing bonds and coupon payments to finance their spending. Although TIPS are low-risk and will protect against inflation, this strategy can be inflexible and may result in your entire retirement fund being depleted after 30 years.

David Rosenstruck, CFP and founder of Wharton Wealth Planning, is a fan of diversified bond ladders for retirees.

“When thinking about laddering, you also have to think about diversification, not just in terms of maturity, but also in the type of securities — so it could be TIPS bonds, corporate bonds, fixed government bonds, municipal bonds,” Rosenstruck said. “Based on the shape of the interest rate curve, you don’t get a lot of compensation from longer-term bonds…it’s safer to be in the one- to nine-year range.”