What is the 4% rule of retirement income?

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How much can you withdraw from your retirement savings without running out of money?

A common rule of thumb known as the 4% rule offers one way to estimate the answer.

According to this rule, if you spend your retirement savings at a rate of 4% the first year and then adjust your withdrawals for inflation every year, your income will probably last three decades.

Say you retire with $1 million. Per the 4% rule:

  • In year 1, you would withdraw $40,000
  • In year 2, if inflation were 2%, you’d take out 2% more, or $40,800
  • In year 3, you’d adjust for inflation again, but based on the previous year’s withdrawal (3% more than $40,800 if inflation were 3%)

This process would continue through year 30.

Benefits of the 4% Rule

With proper planning, using this strategy could:

  • Help you avoid outliving your retirement savings
  • Provide steady, predictable income for many years
  • Enable you to keep a portion of your retirement portfolio invested longer, which would allow your investments to potentially continue to grow

The 4% rule is relatively easy to understand and follow, but there are things you should consider before using it.

Is the 4% rule accurate?

Not always. It’s based on assumptions that may not apply. In fact, some experts consider it outdated.1 The rule:

  • Assumes your expenses will be the same every year, rising only for inflation; however, you may spend different amounts each year as your lifestyle changes
  • Assumes that your portfolio consists of 50% stocks and 50% bonds; depending on if your portfolio is set up differently, you may have different rates of return
  • Assumes you need your portfolio to last 30 years; depending on your planned retirement age, you may need it to last a different number of years
  • Assumes future market conditions will be similar to those in the past

So, while it’s called the 4% rule, it’s best to use this approach as a guideline instead. You may need to adjust the percentage based on your personal situation and goals. You also may need to save more between now and retirement in order for the 4% rule to meet your income needs.

How do I estimate how much I need to save?

For the 4% rule to work, many people use the 25x rule to estimate how much they need to save. To do so, calculate your anticipated annual expenses in retirement, then multiply the total by 25. That provides a target savings amount.

The idea is to save the target amount before you retire, then use the 4% rule to guide your withdrawals after. Keep in mind that this strategy doesn’t account for additional retirement income or expenses you may have.

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Planning your retirement income strategy can be complex.

You don’t want to spend down your savings too fast, but you also don’t want to be too conservative and miss doing things you enjoy. Consider consulting a Retirement Specialist to personalize your strategy.

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[1] "Experts say the 4% rule, a popular retirement income strategy, is outdated," CNBC (Nov. 11, 2021)