What Is the 4% Rule of Thumb?
The 4% rule is one of the best methods for effectively managing retirement withdrawals. This rule suggests withdrawing 4% of your retirement savings each year (with adjustments for inflation starting from the second year) to ensure the continued financial returns of the savings over a 30-year period.
Who Made the 4% Rule?
The 4% rule was established based on a study conducted by William Bengen in 1994. In this study, Bengen explored sustainable withdrawal rates for retirement portfolios over a 30-year period from 1926 to 1963. The study concluded that a 4% initial withdrawal rate allows the portfolio to survive for 30 years regardless of market conditions.
How Does the 4% Rule of Thumb Work?
If you retire with a million-dollar investment portfolio, you would withdraw $40,000 in the first year according to the rule. In subsequent years, you would withdraw $40,000 plus inflation. For example, if inflation in the second year is 3%, you would withdraw $41,200. The additional $1,200 compensates for inflation, ensuring you maintain your standard of living.
Grain of Salt
While the 4% rule can be useful for retirement planning, it has some drawbacks and may not fit all retirement scenarios.
4% Rule vs. $1,000-a-Month Rule
The $1,000-a-month withdrawal rule is another strategy for sustainable retirement withdrawals. This rule assumes you start with $240,000 in retirement savings and withdraw $12,000 annually over 20 years, or $1,000 monthly. Under this rule, you may need lower living expenses or additional income to help compensate for the monthly withdrawals.
4% Rule vs. 25x Rule
The 25x rule is not a retirement withdrawal rule, but a kind of prerequisite for the 4% rule. The 25x rule states that if you save 25 times your annual desired retirement income, you can withdraw 4% of that amount each year, and it will last for 30 years.
Frequently Asked Questions (FAQs)
How long will my retirement last if I withdraw 4% per year?
It’s impossible to predict exactly how long your retirement savings will last, as market behavior and inflation trends cannot be accurately forecasted. The 4% rule is a good starting point, but it’s important to work with a financial advisor to take into account your personal circumstances and needs.
How do I account for inflation in retirement planning?
Inflation should be a fundamental part of your retirement plan, from the beginning of your investments to the time you prepare your annual withdrawal plan. Since inflation averages between 2% and 3% per year, you should consider the increase in the total amount you will need at retirement, and your annual withdrawal amount will need to increase based on inflation each year during retirement.
Source: https://www.thebalancemoney.com/dont-confuse-these-two-retirement-rules-of-thumb-453920
Leave a Reply