It’s helpful to know how much money you need to retire or how much income the money you have will provide in income.
The 4% rule it’s an approximation to help with both questions. It states that: If you withdraw 4% of your initial retirement savings per year. Your savings will last 30 years. The payments will keep up with inflation.
For example, according to the 4% rule:
If you have $1,000,000 of retirement savings when you are 65 years old.
You can spend $40,000 per year (the amount increases with inflation) and it will be all spent when you are 95 years old.
$40,000 was calculated by taking 4% of $1,000,000.
This is helpful to know however it is only a rough estimate.
The 4% rule can be used to determine how much you need to save:
If you need $80,000 per year from your investments for 30 years
You need to have about $2,000,000 saved at retirement.
$2,000,000 was calculated by taking $80,000 / 4%
It’s only a rough estimation
- This assumes 70% of your portfolio is in stocks
- It does not consider taxes from withdrawals
- It’s not considering if the accounts are taxable or not tax differed
- It does not consider changes in cash flow needs over time
- It doesn’t include you taking social security or having other streams of income that may change your income needs
- It does not know what the actual returns will be on your investments
Even with its limitations the 4% rule is a great tool to estimate how much income your investments will provide. You can adjust it if your portfolio is more conservative, if you need more than 30 years of income, or if most of your accounts are tax differed.
Spend less than you earn and invest the rest.