The seven percent rule for retirement is a rule of thumb that suggests retirees can withdraw seven percent of their retirement savings annually without depleting their funds.
In this article, we’ll explore the origins and validity of the 7 percent rule, weigh its pros and cons, and consider alternative approaches to retirement withdrawal strategies.
For personalized guidance, consult a financial advisor from ARQ Wealth who has expertise in retirement planning by calling (480) 214-9572.
What Exactly Is the 7 Percent Rule for Retirement?
The 7 percent rule for retirement posits that a retiree can safely withdraw 7 percent of their retirement portfolio each year, adjusted for inflation, with a reasonable expectation that their savings will last for the duration of their retirement, typically assumed to be 30 years.
This contrasts with the more conservative 4 percent rule, which was popularized by the 1994 Trinity Study.
The 7 percent rule is less formally established and often arises in discussions among financial planners or online forums rather than in rigorous academic studies.
It’s sometimes proposed as an option for retirees with shorter expected retirement periods, higher risk tolerance, or more aggressive investment portfolios.
However, its authenticity is debated, as it lacks extensive research backing as opposed to the 4 percent rule.
The Authenticity of the 7 Percent Rule
The origins of the 7 percent rule are less clear than those of the 4 percent rule.
The latter was derived from historical market data analyzed in the Trinity Study.
Conversely, the 7 percent rule is not based on a specific, widely recognized study. It may have emerged from optimistic assumptions about market returns, particularly during periods of strong economic performance, or as a rule of thumb for retirees with shorter time horizons (e.g., 10–15 years) or those heavily invested in equities.
However, historical data suggest that a 7 percent withdrawal rate significantly increases the risk of depleting savings, especially over a 30-year retirement.
For example, a portfolio with a 50/50 stock-bond allocation, subjected to a 7 percent withdrawal rate, faces a high probability of depleting its funds within 15–20 years under average market conditions, according to Monte Carlo simulations. This raises questions about the rule’s reliability for most retirees, particularly those with longer life expectancies.
Given its lack of empirical backing, the 7 percent rule should be approached with caution. Its authenticity is questionable without personalized financial analysis.
Pros of the 7 Percent Rule
Despite its risks, the 7 percent rule has some potential benefits, particularly for specific scenarios:
Higher initial income: A 7 percent withdrawal rate would allow you to access more money early in retirement, which can be appealing for those who want to travel, pursue hobbies, or cover higher expenses in their early retirement years. For example, a $1 million portfolio would provide $70,000 annually at a 7 percent rate, compared to $40,000 with the 4 percent rule.
Suitable for shorter retirements: If you expect a shorter retirement horizon—say, due to later retirement or health considerations—a 7 percent withdrawal rate may be sustainable. For instance, someone retiring at 75 with a 15-year horizon might find this approach viable.
Aggressive portfolio growth: Retirees with portfolios heavily weighted toward equities (e.g., 80% stocks) may assume higher average returns, potentially supporting a 7 percent withdrawal rate in bullish markets. Historical data shows that stocks have averaged around 10% annual returns over the long term, though this includes significant volatility, which can increase sequence of returns risk.
Flexibility for early retirement: For those retiring early (e.g., in their 50s), a higher withdrawal rate might align with a plan to rely on other income sources, such as Social Security or pensions, later in life.
Cons of the 7 Percent Rule
The drawbacks of the 7 percent rule are significant and often outweigh its benefits for most retirees:
High risk of early depletion: The most critical concern is the increased risk of running out of money. A 7 percent withdrawal rate, especially with inflation adjustments, can quickly erode a portfolio, particularly during market downturns. For example, a bear market early in retirement could significantly deplete funds, as it may be necessary to sell assets at depressed prices.
Sequence of returns risk: The order in which investment returns are realized matters immensely. If a portfolio experiences poor returns in the first few years of retirement, a 7 percent withdrawal rate could lead to a rapid depletion of assets, making it difficult to recover during subsequent market upswings.
Inflation challenges: Inflation erodes purchasing power over time. A 7 percent withdrawal rate, adjusted for inflation (e.g., 3% annually), could mean withdrawing significantly more in later years, further straining the portfolio. For instance, a $70,000 withdrawal in year one could grow to over $125,000 in 20 years, assuming 3% inflation and constant purchasing power.
Lack of empirical support: Unlike the 4 percent rule, the 7 percent rule lacks robust historical data to validate its sustainability. This makes it a riskier strategy, as it relies on optimistic assumptions about future market performance.
Not universal: The rule doesn’t account for individual factors such as life expectancy, healthcare costs, or unexpected expenses. Retirees with longer lifespans or significant medical needs may find the rule unsustainable.
How Long Will My Money Last with the 7 Percent Rule?
The answer to this critical question depends on several factors, including portfolio size, asset allocation, market performance, and inflation.
With a 7 percent withdrawal rate, a $1 million portfolio might last 15–20 years under average market conditions, assuming a balanced 50/50 stock-bond allocation.
However, in adverse scenarios, such as a prolonged market downturn or high inflation, funds could be depleted in as little as 10 to 12 years.
To illustrate, consider a retiree withdrawing $70,000 annually from a $1 million portfolio, adjusted for a 3% inflation rate.
If the portfolio earns an average return of 6% (a reasonable estimate for a balanced portfolio), the funds could be exhausted in approximately 16 years, according to basic depletion models. This assumes no major market crashes or unexpected expenses, which could accelerate depletion.
For a more precise estimate, please call ARQ Wealth to speak with one of our expert financial planners. It is essential to work with a financial advisor who can provide a tailored analysis of how long your money will last, based on your specific circumstances.
Alternative Approaches to Retirement Withdrawals
Given the risks of the 7 percent rule, you may want to consider more conservative or flexible strategies to ensure their savings last:
The 4 Percent Rule
The most widely accepted approach, the 4 percent rule, offers a higher probability of sustaining a portfolio for 30 years. It’s better suited for retirees with longer investment horizons or those who prioritize security over higher initial withdrawals.
Dynamic Withdrawal Strategies
Instead of a fixed percentage, dynamic strategies adjust withdrawals based on market performance or portfolio value. For example, you might withdraw 5% in strong market years and reduce your annual withdrawal rate to 3% during downturns, thereby preserving capital.
Bucket Strategy
This approach divides savings into “buckets” based on time horizons. Short-term buckets hold safe assets (e.g., bonds or cash) for immediate needs, while long-term buckets invest in growth assets (e.g., stocks). This can mitigate the sequence of returns risk.
Floor-and-Upside Strategy
You could ensure essential expenses are covered by guaranteed income sources (e.g., Social Security, pensions, or annuities), then use portfolio withdrawals for discretionary spending. This reduces your reliance on market performance.
Guardrail Approach
Establish upper and lower withdrawal limits (e.g., 5%–8%) based on the portfolio’s performance. If the portfolio grows significantly, increase withdrawals; if it declines, cut back to preserve capital.
The Importance of Consulting a Financial Advisor
While the 7 percent rule for retirement may seem appealing for its promise of higher withdrawals, its risks make it unsuitable for most retirees without careful analysis.
Retirement planning is not a one-size-fits-all approach; factors such as life expectancy, healthcare costs, lifestyle goals, and market conditions must be carefully considered.
A financial advisor from ARQ Wealth can help you:
- Assess your risk tolerance and investment preferences.
- Run personalized simulations to estimate how long your money will last.
- Develop a withdrawal strategy tailored to your needs.
- Incorporate tax planning, estate planning, and other financial considerations.
To explore the 7 percent rule or alternative strategies, reach out to a wealth manager who can provide data-driven insights and create a customized plan to ensure your retirement savings last as long as you need them to.
Bottom Line
The 7 percent rule for retirement offers the allure of higher withdrawals but comes with significant risks, including the potential to deplete savings prematurely.
While it may suit retirees with shorter horizons or aggressive portfolios, its lack of empirical support and vulnerability to market volatility make it a risky choice for most.
A financial advisor with ARQ Wealth can help you craft a retirement strategy that aligns with your goals and ensures financial peace of mind throughout your golden years.
Call us at (480) 214-9572 or use our contact form to get in touch with a financial advisor.