The 4% rule: the basics

The 4% rule is a popular method for taking pension income. It’s designed to make sure that retirement savings last for at least 30 years.

Its founder, William Bengen, looked at past market performance and the effect of financial crises to try and create an easy-to-follow rule of thumb for retirees.

Its benefits are that it’s straightforward and easy to understand. However, some warn that a more dynamic approach is required.

How does the 4% rule work?

In the first year of retirement, you withdraw 4% of your portfolio’s value. In all subsequent years you take the same cash amount but adjust for inflation.

This allows you to keep pace with the rising cost of goods and services while also making sure your pot isn’t exhausted too soon. Even taking into account market crashes and years of underperformance, those using the rule should see their savings last for 33 years.

The rule is underpinned by an assumption that the portfolio is roughly evenly split between stocks and shares and government gilts or bonds. The chosen amount means that the majority of future withdrawals should come from dividends and investment returns.

Downsides of the rule

There are some who argue that using such a rigid rule in retirement is not appropriate. Even Bengen it said it was for a ‘worst-case scenario’ and a starting figure of 5% might be better for many.

It is also possible that 4% of your portfolio will not be enough to fund your lifestyle for a year – even when combined with the state pension.

However, you also need to avoid splurging early on in retirement on major purchases. The rules’ success is based on future investment returns. Using a chunk of your pot early on will limit these returns and could mean you run out of money too early.

This is why some believe that more flexibility is needed. However, if you’re worried about making your savings last in retirement the 4% rule could prove to be a useful guide.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.