CNBC Explains

What the heck is this 4% rule?

What the heck is this ‘4% rule’?
What the heck is this ‘4% rule’?

What exactly is the 4 percent rule? It's a rule of thumb used to determine the amount of funds to withdraw from a retirement account each year.

The 4 percent rule seeks to provide a steady stream of money to the retiree, while also keeping an account balance that will allow those funds to be withdrawn throughout the person's retirement years. It's considered to be a "safe" rate, with the withdrawals consisting primarily of interest and dividends.

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While the withdraw rate is kept constant, it can be increased to keep pace with inflation. It sounds great in theory. However, that rule is broken, said Jon Stein, the CEO of Betterment.

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New research shows that this rule doesn't work for retirees in today's low-rate environment, explained Stein, whose Web-based money-management firm ranked 45th on the 2014 CNBC Disruptor 50 list.

Technology has come a long way since the 1990s, when the 4 percent rule was first introduced. There is an emerging class of services from tech-savvy investment managers that provide dynamic withdrawal rates using algorithms that look at market performance, balance and terms of portfolio, all of which work together to ensure you won't run out of money, he said.