What is the 4% Rule for retirement?
The 4% rule for retirement is a guideline for determining how much money you can safely withdraw from your retirement savings each year without running out of money. The rule was first proposed by financial planner William Bengen in 1994, and it has since become a widely accepted rule of thumb for retirement planning.
Bengen’s research found that this system allowed for retirement portfolios to last for at least 30 years, with some able to last even 50 years plus.
According to the 4% rule, you should aim to withdraw 4% of your retirement savings in the first year of retirement, and then adjust that amount each year for inflation. For example, if you have $1 million in retirement savings and you follow the 4% rule, you would withdraw $40,000 in the first year of retirement.
The 4% rule is based on the assumption that you will invest your retirement savings in a diversified portfolio of stocks and bonds, and that the portfolio will earn an average annual return of about 6-7%. The rule assumes that you will withdraw 4% of your savings in the first year of retirement, and then adjust that amount for inflation each year to maintain your purchasing power over time.
Let’s take a look at an example.
| Year | Withdrawal Amount |
|---|---|
| 1 | $40,000 |
| 2 | $40,800 |
| 3 | $41,600 |
| 4 | $42,432 |
| 5 | $43,281 |
In this example, we assume that you have $1 million in retirement savings and that you plan to retire at age 65. Based on the 4% rule, you would be able to withdraw $40,000 in the first year of retirement ($1 million x 4%), or $3,333 per month. In subsequent years, you would adjust this amount for inflation (assuming an inflation rate of, say, 2%), which would bring your withdrawal to around $40,800 in the second year ($40,000 x 1.02), $41,600 in the third year ($40,800 x 1.02), and so on.
The 4% rule is based on historical data that suggests that a 4% withdrawal rate is sustainable over a long period, such as 30 years of retirement. It’s important to note, however, that the 4% rule is just a guideline and may not be appropriate for everyone. Factors such as your age, the length of your retirement, your investment portfolio, and your personal financial circumstances can all impact how much you can safely withdraw from your retirement savings.
Another popular retirement ‘rule’ is the 25x rule.
Pros and Cons of the 4% rule
Pros:
- Provides a simple, easy-to-follow guideline for determining how much you can safely withdraw from your retirement savings each year.
- Based on historical data and the assumption of a diversified portfolio, which gives it a strong foundation.
- Can help you plan your retirement spending and ensure that your savings last for the duration of your retirement.
Cons:
- May not be suitable for everyone. Your actual retirement spending needs may be different based on factors such as your expected lifespan, your desired lifestyle in retirement, and your risk tolerance.
- Does not take into account changes in market conditions or other unpredictable events that could affect your retirement savings.
- May not allow for enough flexibility to accommodate unexpected expenses or changes in your retirement plans.
Can the 4% rule work for early retirement?
The 4% rule is designed to assume a standard retirement age of 65. If you’re wanting to retire earlier then your financial needs will be different and you may need to plan differently.
Does the 4% rule still work for retirement planning?
Overall, the 4% rule can be a useful guideline for retirement planning, but it’s worth remembering that it is just a rule of thumb and that your actual retirement spending needs may be different. It is a good idea to work with a financial planner or advisor to create a personalized retirement plan that takes your individual circumstances into account.
