Today we’re going to talk retirement. Whether you’re young or mature (😉) you want to pay attention. You might be doing a lot of work to get your finances in order and budget correctly, but if you don’t understand the end goal, you can lose motivation. Today we want to tell you about a simple concept called the 4% rule that can help you know when exactly how you can plan to retire. It may be sooner than you think and it hopefully is much simpler than you think. So, let’s dive in.
What is the 4% rule?
Originally coined in 1994 by financial advisor Bill Bengen, the 4% rule simply states that you can withdraw 4% from retirement savings each year and never run out of money for a 30 year period.
That amount, adjusted for inflation as needed, is supposed to establish a safe, steady and simple way to manage income while retired.
Say an investor has retired with a $1 millionExample of the 4% rule as shown in Vanguard’s research paper “Fuel for the F.I.R.E: Updating the 4% for early retirees.
portfolio. In her first year of retirement, under
the 4% rule, she should withdraw 4% of that
portfolio, or $40,000 ($1 million x 0.04). For each
subsequent year, she should adjust the withdrawal
amount for inflation. For example, if in the following
year inflation is 2%, she should increase the
withdrawal by $800 ($40,000 x 0.02), to $40,800
Can you retire early using the 4% rule?
You simply need to do your homework to figure out if the 4% rule works for you. Here are the steps you’ll need:
- Determine how much you will need each year to retire. Consider housing, food, transportation, healthcare, travel, kids, pets, hobbies, fun money and everything else that will be part of your expenses. (Source)
- Next, you can consider any other income you may have coming in for retirement other than your savings. This may be social security, pensions, disability or anything else.
- With those two numbers, you now know how much you will need to pull out of retirement every year to live the lifestyle you want to live.
- So, let’s say you came up with $30,000 is how much you’ll need each year. Now you can divide that by 4% and get $750,000.
- Generally, you need to save up $750,000 in order to be able to retire for about 30 years and have a steady stream of income!
Is the 4% rule still valid? Can I trust the 4% rule?
Well, we are not financial advisors. We absolutely recommend you work with one to get a bit more detailed on your retirement plans. What the 4% rule does do is allow you to do your own math and arrive at a decent conclusion about retirement. Sometimes it seems to complicated and scary. We want you to be comfortable and confident when it comes to your finances. Furthermore, this is only one part of the retirement story. You may want to leave a legacy or need money to last shorter or longer, so be sure to talk to someone to get specific!
Pros of the 4% rule
- It’s simple & easy to follow.
- 4% is actually pretty conservative, most people withdraw more.
Cons of the 4% rule
- Assumes 30 years.
- Assumes a specific type of investment portfolio (50% S&P and 50% bonds).
- It’s a “worst-case scenario” which basically means you’re being super-frugal.
- Assumes 7% return rate & inflation rate of 3%.
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