Personal Finance

Does the 4% Retirement Spending Rule Still Hold Up—And Where Do Rentals Fit in?

Expertise: Landlording & Rental Properties, Real Estate News & Commentary, Personal Finance, Real Estate Investing Basics
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retirement-income

Personal finance nerds (like myself) spend an inordinate amount of time thinking about retirement.

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How much do you need? How can you ensure that you don’t run out of money in retirement? What’s the fastest way to get there, and does fast also mean safe?

For the last 20 years, the 4% rule (a.k.a. the 25X rule) has been something of an industry standard. At the very least, it’s been a shorthand to use as a reference point. But for all its simplicity, how “true” is it? Does it leave room for shortcuts?

Is it even still relevant in today’s economic environment? And where do rentals fit in?

But we’re getting ahead of ourselves. Let’s start at the beginning.

How Did the 4% Rule Come About?

Back in the ‘90s, financial advisor Bill Bengen introduced the idea of the “4% rule.” It’s simple enough: A retiree can afford to withdraw about 4% of their nest egg each year, if they want it to last them 30 years. Bengen proposed this rule after analyzing historical stock and bond market returns and found a 4% withdrawal rate to be safe for retirees.

On the simplest level, it makes sense. If your stock portfolio rises in value by an historically-reasonable 7%, and you subtract out 2% of that for inflation, that leaves a “real” return of 5%. You take 4%, and voila! Your stock portfolio’s value actually rose by 1% over the course of the year, even though you sold off some of it.

The other way of thinking about this rule is by its other name, the 25X rule. It dictates that investors will need a nest egg of 25 times their annual spending if they want to live on 4% of it each year. Thus, if you want to withdraw $40,000/year as income, you’ll need a $1,000,000 nest egg.

How Does the 4% Rule Hold up in Today’s World?

First, consider the simplest problem at all: What if you live for more than 30 years after retiring?

Americans who reach 60 can expect to live into their 80s—and increasingly live into their 90s or even become centenarians. So, this 30-year timeline may not leave every 60-year-old jumping for joy.

Related: 7 Achievable Steps to Reach 7-Figure Retirement Savings

And hang on a second—does it even guarantee you 30 years of income?

Of course not. Aside from the possibility that you invested money in the next Enron, the market could crash right after you retire. One T. Rowe Price study found that, moving forward, there’s 90% probability that retirees following the 4% rule won’t run out of money in 30 years. This means that a troubling 10% of the time, retirees could expect to run out of money.

Bonds, interest rates, market crashes, oh my!

Some of your retirement portfolio is probably made up of bonds, not stocks. And in the ‘90s, when Bengen proposed this rule, interest rates were high and bonds paid well.

In a low-interest environment (like we’ve seen in this century), investors can’t expect much in the way of returns from them. They also have a fixed lifespan and run out eventually. Still, retirees often still rely on them because of their greater reliability over stocks.

That T. Rowe Price study above was based on a 60% stocks/40% bonds allocation, just like Bengen’s original proposed rule allocation. But not everyone uses this asset allocation. What if you retire with half of your portfolio in stocks and half in bonds? A Vanguard study found that over 35 years, the rule only worked 71% of the time under these conditions.

Here’s the other big risk with the 4% rule: what if the market crashes right after you retire? If you’re only pulling money out when a market crashes and not putting any money back in, then it’s all downside for you. You lose money on the crash, but don’t make any money by investing in the recovery.

Sure, the market will eventually recover, but between now and then, you will have had to draw down significantly on your balance. When the recovery comes, your remaining portfolio will be much smaller, leaving less to regain lost ground with.

For all that, financial planner Michael Kitces points out that over the last 150 years, there has not been a 30-year period when someone following the 4% rule would have run out of money.

The Wild Card: How Rentals Change the Math

Here’s where things get interesting. What happens when rentals enter the mix?

In our earlier example, we decided we wanted $40,000 in income post-retirement in addition to Social Security, which would mean a $1,000,000 nest egg. That comes to $3,333/month.

Our imaginary friend Michelle invests $250,000 in a fourplex that rents for $3,600/month. After expenses, let’s say she earns $1,800/month on it.

Now she only needs another $1,533/month, or $18,396/year, from her stock portfolio. That means a nest egg of $459,900.

See what happened there? Michelle’s total sum needed just dropped from $1,000,000 to $709,900 ($250,000 for the fourplex, $459,900 for stocks). She just trimmed nearly $300,000 off her total necessary assets!

great-deal

The Balance Between Rentals and Stocks

Sometimes stock markets crash. Sometimes rental properties hit their owners with several expenses at once. But that’s the beauty of diversification—those two events almost always remain unrelated.

During the Great Recession, U.S. stocks crashed by around 30%, and real estate values dropped similarly. But rents did not drop. Why? Because so many homeowners became renters that the demand for rental housing actually increased.

Smart landlords set aside money for repairs, vacancy rate, CapEx, etc. into a property fund each month, so that when a turnover or a $5,000 roof bill comes along, they’re prepared for it. But imagine that several turnovers and a huge roof bill happen to come along all at once. A retiree can draw a little extra from their stock portfolio that month to cover the difference.

Related: Want to Retire Early? Sorry, But Much of Your Net Worth May Not Help

When landlords see strong performance from their rentals, they can always invest extra in their stock portfolios. Likewise, when their stock portfolio is suffering, landlords might postpone a property upgrade they’d been considering and lean more heavily on their rental income.

And there’s that little matter of inflation; rents rise alongside (or surpass) inflation. That makes rentals an excellent hedge against it.

Diversification is a beautiful thing.

The Exponential Impact of Spending

Consider this side of the 25X rule: It highlights just how costly each extra dollar of spending is for your bottom line.

For every $100/month that you spend, you’ll need an extra $30,000 in your nest egg, according to the 25X rule. Seriously, $100/month is $1,200/year, which multiplied by 25 is $30,000.

Is your cable bill really worth having to invest another $30,000? What about that latte habit?

At the risk of sounding like a nag, if you cut that spending now, you can invest it and reach your nest egg goals much, much faster. For a tough (but rewarding!) challenge, try living on half your income and investing the rest.

Eyes on the Prize: Financial Independence

For me, the point of investing is clear and simple: replacing active income with passive income. On the day when my passive income can cover my expenses, I’ll reach financial independence, and every day that I work thereafter will be a choice.

Any discussion of withdrawal rates (e.g. the 4% rule) rests on an underlying fear. At its heart, the discussion revolves around “how much of my portfolio can I sell in a given year, with a reasonably low risk of running out of money?”

I don’t want to worry about running out of money. I want my portfolio to keep growing even after I retire. And to do that, all I must do is focus on building passive income. Rental properties, stock dividends, and bonds all offer it.

You can still sell off stocks in retirement, of course. Selling off 2%, 3%, even 4% will almost certainly leave you in fine shape. But if you can keep that number under 3-4%, and replace a healthy chunk of your monthly income with rents instead, your nest egg will almost certainly grow rather than shrink.

[Editor’s Note: We are republishing this article to help out our newer readers.]

How is your retirement investing coming along? What tips do you have to get there even faster?

Leave your thoughts and questions below!

G. Brian Davis is a landlord, personal finance expert, and financial independence/retire early (FIRE) enthusiast whose mission is to help everyday people create enough rental income to cover their living expenses. Through his company at SparkRental.com, he offers free rental tools such as a rental income calculator, free landlord software (including a free online rental application and tenant screening), and a free masterclasses on how to reach financial independence within 5 years.

    Chad Carson Investor from Clemson, SC
    Replied about 2 years ago
    Brian, this is an excellent presentation of the 4% rule and real estate! I count myself in the personal finance nerd category like you and think (and write about) this stuff way too much:) I completely agree that rental income changes the math. It’s like a pension income that puts a relatively secure floor on your retirement income. The stock portfolio is then for extra growth and diversification. Like you said, when rentals do great, buy more stocks/bonds. When stocks/bonds do great, buy more real estate. In addition to rentals and stocks, I like private note investing instead of bonds. I’m curious if that play in at all to your personal diversifcation?
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    Thanks Chad! By the way I discovered your blog recently (via a guest post you wrote for BudgetsAreSexy), I’ve been thoroughly enjoying it as a fellow personal finance nerd 🙂 I have done some private note investing in the past, and had good experiences, although I’m not currently. Right now my funds are tied up in expanding my business.
    Mark Spidell from Glenwood Springs, Colorado
    Replied about 2 years ago
    Nice article! One dynamic of long term rentals is the potential of housing market changes and how it might impact retirement planning. I think most people can agree that it is harder to find cash flowing properties in a lot of markets compared to a few years back, so investors have to stay dynamic with there real estate diversification. Consider these scenarios: 1. After 20 years, your properties might have appreciated so much that you are renting properties that no longer have a very good rent to value ratio. Perhaps transition into muni bonds depending on your tax situation or transition to a different market. 2. Let’s say your market disappears. Imagine if you started building a rental portfolio of income properties in Detroit in the mid sixties with a 30 year horizon! Hopefully adjustments are made over time vs. being a frog in boiling water!
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    Very true that markets constantly evolve, and you have to keep an eye on them to decide if the time has come to sell. Rentals tend to do quite well over a long time horizon though, appreciating in value while rents rise with inflation. Still, as you point out, “usually” is not the same as “always”.
    Ted Carter Real Estate Investor from Blackville, South Carolina
    Replied about 2 years ago
    Good article. Over the years I have read so much about the 4% rule. The simple solution for me is remove money from your IRA when the market is up – go TRUMP – and less in year like 2008 when the market is down. Maybe it is simple as that ?????. The thing about stocks is the price, one day it is up, the next day down and you have absolutely no control. Ride it out is the only choice you have. With the rentals you do have a level of control – even in a no growth area like mine – the income is steady – you can ride by and see it – touchy feele thing – no big up and downs, oh sure some times we have issues with renters but what LL doesn’t.
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    That’s one of the things I love most about real estate as an investment class: the control you have over it. That, and its much lower volatility, as you also mentioned.
    Sonia Spangenberg from Manassas, VA
    Replied about 2 years ago
    SONIA on AUGUST 25, 2017 8:42 AM Well explained for the non financial nerd! Thanks.
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    Thanks Sonia! Although if you’re a BiggerPockets reader, you probably know a lot more than the average Joe 🙂
    Eric Egeland Specialist from Long Grove, IL
    Replied about 2 years ago
    Great post
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    Thanks Eric!
    Susan Maneck Investor from Jackson, Mississippi
    Replied about 2 years ago
    This is a good reminder not to think in terms of either/or but *both.* One thing I would add to this is except in the case of a major crash which hurts both sources of income, avoid taking out Social Security until you are 70. It increases by 8% every year you leave it alone. One other thing that should be probably kept in mind is that real estate investments aren’t all that passive and if we live long enough there will likely be a time when we will need to dispose of our portfolios. One solution to insuring that there will be enough money on into our late eighties or nineties is to purchase a Qualified Longevity Annuity. This can be done inside a retirement fund but is not subject to required minimum distribution rules until your contract actually begins to pay out, usually when you are 80 or 85. Let’s say you invest 100K into it when you 65. At 85 it will produce over $2800 in income, probably enough to replace that rental income. And the nice part of it is that it leaves you free to spend the rest of your portfolio without worrying about running out.
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    Great point Susan about postponing Social Security as long as possible! Likewise that retirees won’t always be able to manage their own properties – I’m a huge believer that investors need to calculate property management fees into their returns and cash flow from Day 1, because sooner or later the time will come when they no longer want to manage their own properties.
    Tim Johnson
    Replied about 2 years ago
    Please be very careful about buying any type of Annuity, 98% are over priced with commissions and there are always better ways to achieve the same goal. Putting a tax deferred vehicle inside a retirement plan is never good.
    John Murray from Portland, Oregon
    Replied about 2 years ago
    Today I turned 59 1/2 plus 1 day. I have about 60K in passive rent profit and gaining 12% per year in leverage on $3M in SFH rentals. Today I have access to another $1.5M without penalty. . In 2 1/2 years the feds will send me another $2.5K per month in SSI on top of my $2.2K defined benefit pension . America is a great place to succeed, you just have to work hard. If an electrician can do this anyone can with hard work and intelligence.
    Michael Ohara Rental Property Investor from Hawaii investing in the Cleveland, OH market
    Replied about 2 years ago
    John, very inspiring!
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    That’s fantastic John! Always great to hear success stories like yours. And you’re absolutely right – in real estate, you don’t need a Ph.D. or to be born with a silver spoon to succeed, it really is a path to wealth that’s open to everyone!
    Rich
    Replied about 2 years ago
    Excellent article! This point is well-taken. I’ve always been interested in tackling the 4% rule and putting it along side rental properties. In my case, I’ve taken most of my S&P 500 index and turned it into rental properties that are paid off and making 8% I like to call it the 8% rule, as that is what I estimate I’m getting. In that case, it only takes $500,000 of real estate to do what $1M does under the 4% safe withdrawal rate. Retire twice as fast, or live twice as large. But there is always a case for diversification.
    G. Brian Davis from Baltimore, MD
    Replied about 2 years ago
    Awesome Rich! Glad to hear your rentals are working so well for you. I agree, rentals definitely help you retire much faster. But as you mentioned, diversification is crucial too, which is why I also keep stocks as part of a balanced investment portfolio.
    Bryce Stewart from Bethlehem, Pennsylvania
    Replied over 1 year ago
    Brian & Rich – Just found this article. As a landlord who retired at the ripe old age of 35 by investing in local, multifamily apartments, I would add two metrics that are not being discussed here: PASSIVITY and SCALABILITY. Yes, you can generate higher returns with real estate than 4% in low cost index funds. But low cost index funds never call you in the middle of the night – they’re never vacant, and they don’t flush diapers down the toilet. Index funds don’t have lawns to mow or sidewalks to shovel. There’s no risk of being sued, and no need to increase your umbrella liability policy. The elements in their water heaters don’t stop working. Index funds don’t wear ‘going-out’ heels on a recently redone 120 year old random width plank heart pine floor. And, as far as I know, they don’t make sex noises on the 2nd floor of a duplex. If you’re committed to stock index funds, there’s not even any yearly rebalancing to do. You can live in Pennsylvania (I do) OR Miami or Puerto Rico or be on vacation in London, and still make the same income from index funds. So the passivity is PURE. My rental units are definitely NOT passive. I manage all 23 of my units, which saves me the cost of property management. I would have to take a pretty big pay cut in exchange for greater passivity, achieved through a PM. Even then, someone has to babysit the PM and make sure they’re not allowing your investment to be destroyed even while they inflate the associated costs of management. So with RE you never really reach the level of passivity you get with index funds. When quantifying this over a 30+ year horizon, that metric HAS to be worth a few % points, especially if you attach a monetary value to your own time. On top of that, RE is inherently less scalable. There’s a built-in ceiling to my approach, as I can only personally manage a certain number of units (I’m just about at my limit.) But even with a property manager, there’s a limit to the scalability most people will be able to achieve. Contrast that with low cost index funds – there’s effectively NO ceiling on the scalability. You can pump as much money into the S&P as you want while still counting on the same historic annualized rate of return AND the SCALE has virtually NO EFFECT ON THE PASSIVITY. Owning $1m in an index fund is exactly as much work as owning $10m or $100m.
    Ramona W. from Colorado Springs, Colorado
    Replied over 1 year ago
    Very true Bryce, and funny too!
    Paul Schu Rental Property Investor from DC NC, NW FL
    Replied over 1 year ago
    Excellent comment! I would add that if you have to babysit the PM then he/she is not the right person for the job.
    MB
    Replied about 2 years ago
    Totally aligned with this strategy. Curious if you income figures are pre or post taxes
    MB
    Replied about 2 years ago
    Totally aligned with this strategy. Curious if you income figures are pre or post taxes
    Mitch H. Investor from Denver, CO
    Replied over 1 year ago
    Michelle is also getting a 34.56% Cash on Cash Return (assuming 25% down), and almost 1.5% Price:Rent. Those are pretty darn good metrics if you ask me…so of course that reduces her required ‘nest egg’ disproportionately compared to her 7% stock market returns. The higher your returns, the less you’ll need. Felt like this was buried in the article…its presuming you find a deal that has higher that your average returns.
    G. Brian Davis from Baltimore, MD
    Replied over 1 year ago
    It’s true Mitch – you definitely to invest in good deals! I’ve had more than my fair share of lemons over the years. But ideally you get those out of the way early in your real estate investing career, and build a portfolio of high-performing properties to help with early retirement.
    tim boehm
    Replied over 1 year ago
    Brian Loved the article, we’ve been in rentals for over 30 years and had planned on selling the works going in to CD’s and traveling. but today a million in the bank won’t pay the light bill. So we are still LL’s awaiting the day interest rates get to 5% and that will make it all good for us!
    tim boehm
    Replied over 1 year ago
    Brian Loved the article, we’ve been in rentals for over 30 years and had planned on selling the works going in to CD’s and traveling. but today a million in the bank won’t pay the light bill. So we are still LL’s awaiting the day interest rates get to 5% and that will make it all good for us!
    G. Brian Davis from Baltimore, MD
    Replied over 1 year ago
    Thanks Tim! So you’re not planning on keeping your rentals in retirement?
    Jane Rogets
    Replied over 1 year ago
    What about the fact that stocks generate capital gains and rentals generate ordinary income? How does that play into the equation?
    G. Brian Davis from Baltimore, MD
    Replied over 1 year ago
    Hi Jane, rental income is roughly analogous to dividend income in stocks, and then when you go to sell either stocks or real estate and cash out, that’s where you get hit with capital gains. But one nice advantage of real estate as an investment class is that you can deduct not only every incurred expense but many paper expenses as well.
    Jane Rogers
    Replied over 1 year ago
    But my understanding is that rental income is taxed at ordinary income rates while qualified dividends (I hold stocks for long-term) are taxed the same as long-term capital gains rates. I want to add real estate to my portfolio, but my financial advisor asked “why replace capital gains rates (for qualified dividends) with ordinary income rates for rent?
    Justin Green Investor from Clackamas, Oregon
    Replied over 1 year ago
    It is taxed at ordinary income tax rates, but it is passive income vs active income I.e. no FICA taxes. Also between the depreciation deduction (for 27.5 years) and the interest deduction (assuming you get a mortgage) you often have a “paper loss” meaning you would not pay any taxes on the rental income. Eventually when you sell you will have to pay the depreciation recapture tax (I believe it is 25% currently) and a long term capital gains tax. BUT both of these can be avoided by using a 1031 exchange into a different property. If you keep using the 1031 until your passing, your heirs would receive the properties at a stepped up basis I.e. the taxes (long term capital gains, depreciation recapture, etc…) get wiped out. Sounds like your FA doesn’t understand RE or has incentive to suggest other financial products. I’m not a CPA, everyone’s situation is different, etc…
    Daniel Dietz Rental Property Investor from Reedsburg, WI
    Replied over 1 year ago
    I think you hit the nail on the head here. One other point is that as your loan gets paid down and the principal-to-interest ratio gets to the point where it lessens to the extent that the depreciation + interest cost no longer offset the cash flow profits and it starts to become taxable income. One way to avoid that, at least in our scenario where we use 20-25 year amortization, is that at about the 10 year point, we can do a tax free cash out refinancing which will give us ‘a lump sum’ but also increase the interest we are paying to the point that we stay in the ‘tax loss’ category. Of course this would have to be ‘tweaked’ to current interest rates, cash flow desires etc…… There is a chance that we could repeat this scenario ‘endlessly’ to a degree depending what our goals are. Dan Dietz
    Pat Tibbetts Investor from San Antonio, Texas
    Replied over 1 year ago
    If you can take flexible distributions (i.e., a fixed percentage of the balance regardless of the amount), it works every time. That means you either have to over-save, or you have to diversify your sources of income in retirement. (Yup, that’s a hint.) ?
    G. Brian Davis from Baltimore, MD
    Replied over 1 year ago
    I’m a huge believer in diversification, and equity portfolios balance rental portfolios quite well. But even within each asset class, diversification will keep you from losing your shirt when one piece of the economic puzzle hits trouble.
    Justin Koehn Real Estate Agent from Olympia, WA
    Replied over 1 year ago
    Brian, thanks for another great article! Always appreciate your writing. One thing that I don’t understand when I talk to most people about retirement (these are NON- BP folks, obviously) is that they say they will have their house paid off, so they will need less money in to live on in retirement. When I hopefully envision my own retirement, I see frequent travel, small splurges, and the ability to generously support my kids, grand-kids, church, and community. None of that sounds like I will need less money. I fully expect to need the MORE money in retirement than I have ever needed before. I don’t understand how “paying off my house” would have any major impact on my retirement. Especially if I have fixed, long term financing and inflation keeps making that debt look smaller and smaller.
    G. Brian Davis from Baltimore, MD
    Replied over 1 year ago
    Thanks Justin! Less debt in retirement certainly can’t hurt, but every dollar you put toward paying off your mortgage could have been invested elsewhere, such as equities or real estate. So it becomes a question of where will that dollar do the best good for you? And to your point, medical expenses can also be quite high in retirement.
    Pat Tibbetts Investor from San Antonio, Texas
    Replied over 1 year ago
    I think paying off the house is a psychological thing for people. Those who do are willing to accept risk in other areas in order to feel secure in their homes. I personally think a big, long mortgage – especially at a low interest rate – is better from a pure mathematical perspective, but retirement age people tend to be more risk-averse, and I understand that impulse well!
    Daniel Somers Rental Property Investor from Tiffin, OH
    Replied over 1 year ago
    Wow love this post
    Chad Peyton Rental Property Investor from Aptos, CA
    Replied over 1 year ago
    Brian, Great job at showing the power of buying cash flowing assets as opposed to accumulating funds in the stock market. I would challenge you on one part though. As you start replacing your active income with passive income why not focus on growing your income in ways that inspire you and create value for others. I’m sure you already are, so why not spread that message. I agree that we should only spend our money on things that bring us value and joy, but instead of promoting shrinking your lifestyle why not show people how to grow with an abundance mindset? Coffee gets such a bad rap! I drive a 13 year old car, but I love a coffee out sometimes. Quit picking on the coffee!! Haha. Trust me, a person’s tax liability will far outweigh their coffee habit.
    Ruth Fermo from Bothell, WA
    Replied over 1 year ago
    Great article Brian! There is a wealth of advice.
    G. Brian Davis from Baltimore, MD
    Replied over 1 year ago
    Thanks Ruth! Greatly appreciated 🙂
    Ryan Roberts Real Estate Agent from Austin, TX
    Replied about 1 year ago
    I believe this rule covers you in perpetuity, not just 30 years like this article says.
    Sean Maloney Rental Property Investor from Columbus, OH
    Replied about 1 year ago
    Great article and thanks for the food for thought.
    Roderick Mills Jr. from Cincinnati, OH
    Replied 8 months ago
    Great article! Explaining the value of diversification was interesting and also showing how you can reach your financial independence goals earlier by having a dual strategy is something I think a lot of people should consider.
    G. Brian Davis from Baltimore, MD
    Replied 8 months ago
    Thanks Roderick, much appreciated, and by the way there’s good data showing that a 3.5% withdrawal rate will never run out of money, for young retirees. Found that fascinating 🙂
    JJ P.
    Replied 8 months ago
    We’re getting about 18K a month on our rentals gross. That nets about 15K monthly/180K a year. The rents are low and creep up over time, so we expect our return to increase steadily over time. Our tenant base is stable, due to the low rents, with minimal turnover and re-renting costs. The mortgages are paid off and we’ll keep this up through retirement until the management of them gets to burdensome. It’s unlikely we’d outsource to a property manager, but it’s possible and would keep the income high. They are a combo of SFH and condos. We’d prefer not to have condos but the purchase price entry point on them was low.