How Much Money Do You Need To Retire? – 4% Rule

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Will the 4% rule hold up to early retirement? Find out and learn about this important early retirement concept.

The latest buzz in our circle of friends has been the question “How much money do you need to retire early?” Some of you will be quite surprised to hear that it may not be as much money as you think. Using the 4% rule your retirement future may be brighter than you thought. 

What Is The 4% Rule?

The 4 percent rule is an investment and retirement strategy that suggests you should withdraw no more than — you guessed it — 4 percent of your retirement savings each year to prevent outpacing your total funds.

When figuring out your retirement goals you should not only use the 4% rule but also take into account Social Security.

1. The 4 Percent Rule (Withdrawals):

This rule says that you can safely withdraw 4 percent of your retirement portfolio each year without running out of money. For example, If you have $1 million in your retirement portfolio, you can withdraw $40,000 per year.  The 4 Percent Rule is our preferred method for retirement.

2. Social Security

Don’t forget that your retirement portfolio is only one piece of your financial future. There is also Social Security and Pensions. 

Approximately 2/3 of Americans don’t get a pension however if you are eligible for one its size and terms are dependent on your employer. Social Security income is difficult to predict especially for the younger generations.

That’s why I am such a fan of focusing on the 4% rule because this is a piece of your future that you can have control over.

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4% rule and retirement

The 4% Rule For Retirement

The 4 percent rule is an important concept to know and understand in the FIRE(Financial Independence Retire Early) scene. As I take you through our journey this is just one of the retirement strategies that we are using to plan and gauge our success.

With the 4% rule, there are 2 things to consider. First, how much you need saved in your retirement account and second, the amount of money you can safely withdraw each year.

So you may be asking. “How much should I really have saved in my retirement account before I can think about retiring early?”  As a rule of thumb with the 4% Rule, you will need 25 times your annual expenses.

What? 25 times you say…. Yes, that’s correct you heard what I am dishing out!  Let’s move on and I’ll explain.

Be sure to read our Comprehensive Guide to Financial Independence.

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“The 4% Rule”, “The 4% Safe Withdrawal Rate” or easier yet the “SWR”

The “SWR” is the rate at which you can withdraw funds from your accounts every year and not run out of money. Of course, this is never a sure thing as it relies on the stock market, but using the information available we can assume with reasonable certainty that this is a safe rate.

4% rule for early retirement

The 4% Rule Calculator

This easy calculation will give you the information you need to keep you financially independent for the rest of your life.   

Take your desired annual income for retirement and multiply by 25.

For this example let’s say you plan to retire on $40,000 a year.  Now, remember this 40,000 a year includes everything.  Taxes, insurance, living costs, lifestyle costs. etc.

25 x $40,000 = $1,000,000

So with this calculation, you would need $1,000,000 to retire. Simple right? I told you.

Now, let’s look at how the 4% rule works on that million dollars.

  • You withdraw 4% of your total account balance the first year of retirement. Then every year following you withdraw 4% plus inflation so that the effective value of the money remains the same.
  • In this example that would be $40,000 for the first year. Then $40,800($40,000 plus 2% inflation), for the following year.

That’s it.  See!  It’s not that difficult after all.  Keep in mind that it all boils down to your expenses and the lifestyle you desire.  If you are one of those people who can’t imagine living on 40,000 a year you will obviously have to save a larger nest egg.

Prove It!  How do we know the 4% Rule actually works?

Here’s a little history. The 4% rule comes from a paper written in 1998 by three finance professors at Trinity University. The original paper is titled “Retirement Savings: Choosing a Withdrawal Rate That is Sustainable.” More commonly referred to as the Trinity Study or 4% rule.

The professor’s sought to determine what a person who retired after 1926 could spend each year for 30 years without running out of all of their money.

Key Points From The 4% Study

  • Historical Data was collected from 1926-2009
  • Portfolios studied were composed of US large-cap stocks and long-term corporate bonds—More info on stocks and bonds below
  • 30-year retirement duration
  • If you withdraw 4% or less of your financial portfolio each year, you can be pretty much guaranteed to live off of your investments for 30 years.
4% rule and retirement

Does The 4% Rule Work?

In one word yes!  As we all know nothing is 100% certain, the 4 Percent Rule is an excellent rule of thumb for both traditional and early retirees.

Does the 4% rule hold up for longer retirement periods?

Michael Kitces at Kitces.com has a lot of great investment strategy and has written several posts on the 4% rule. Kitces has done a retrospective look at the 4% rule to see how it would have faired during the 2000 and 2008 financial crisis.

I would encourage you to check out his article, here is an excerpt from Kitces.

In fact, “Over 2/3rds of the time the retiree finishes the 30-year time horizon still having more-than-double their starting principal. The median wealth at the end – on top of the 4% rule with inflation-adjusted spending – is almost 2.8X starting principal. In other words, it’s overwhelmingly more likely that retirees will have opportunities to ratchet their spending higher than a 4% rule, than ever need to spend that conservatively in the first place!”-Kitces

Kitces goes on to say that the 4% rule has a 96% probability of leaving you more than 100% of your original starting principal-Kitces

4% rule for early retirement

What About Market Crashes?

The Trinity Study examined 54 separate time periods.  Within these time periods, some of the biggest stock market crashes in our history occurred (Wall Street Crash of 1929 and Black Monday Crash in 1987). 

Even with these large market crashes, it was still found that a person could live for 30 years off of a 4% withdrawal rate.

“The bottom line, though, is simply to recognize that even market scenarios like the tech crash in 2000 or the financial crisis of 2008 are not ones that will likely breach the 4% safe withdrawal rate, but merely examples of bad market declines for which the 4% rule was created”. —Michael Kitces

Stocks Vs. Bonds

I told you I would get back to covering stocks and bonds.  To put it simply, stocks are what have the most potential to make you money but also suffer the most during the lows.

Bonds, on the other hand, are more stable but don’t get you as big of returns.

A good mix of the two is important for long-term success using the 4% rule. For a 30-year retirement plan, a 50/50 stock/bond mix is appropriate.

For longer periods, a person should bump their stocks up to 65% and maybe even as high as 80% for those 30 somethings seeking FIRE.

What Should I do If I want A Longer Retirement Than 30 Years?

Long-term projections of the 4% rule, let’s say 50 years, may require a lower withdrawal rate. Kitces recommends that you could drop the rate to 3-3.5% to be extra safe. Remember these rates are based on 100% of your income coming from this account.

Now, I don’t know about you but I’m not planning to never work again, I love being busy and taking on various projects. In addition, the 4% Rule for retirement doesn’t factor in things like Social Security.

For this reason, we are sticking with the 4% rule and will do some work on the side to provide additional padding to our retirement.

4% rule for early retirement

So What Is A Safe Withdrawal Rate For Yourself?

Based on the discussion above, you may be wondering should you choose a 3% or 4% withdrawal rate when planning for your own retirement?  I can’t tell you a hundred percent, but I’ll try and provide a couple of guidelines that make sense to us. Here are some of our ideas of how the 4% rule for retirement withdrawal works for retirees at different stages in their lives. 

Young Retirees

If you plan on FIRE’ing (Financial Independence/Retire Early) in your early to mid 30’s you will need a portfolio that supports 60+ years of expenses.  In this case, I would consider a 3% withdrawal rate for the first 10 years to avoid depleting your principal too quickly.  In really good economic years you can decide if you take the full 4% and in the bad years, you can take half the amount.

Traditional Retirees 

If you want to retire in your 60’s, I would plan on the traditional 30-year window for retirement.  Based on all the research above I think that the 4% Rule is a completely reasonable path.

How To Make Retirement Even Safer

So how can we pad this further? First of all, find some sort of work or income that you really enjoy and gives you the freedom of retirement.

It doesn’t have to be a lot of money and it doesn’t have to be consistent.  Maybe you like to work a few months out of the year just twice a week at the local ski hill. This will make a huge difference.

Emergency fund! Very important that everyone makes this a priority. Consider upping your emergency fund to help with any unplanned expenses. Be sure to read up on Health Savings Accounts (HSAs) as they are crucial to early retirement and should be maxed out every year if available to you.

3 Tips to Boost Your Retirement Savings

Here are three tips to maximize your retirement income

  1. Open a high yield savings account that earns an excellent interest rate. This kind of account allows you to save money and earn over 15x the national average interest, depending on your balance and contributions.  Check out Cit Bank Money Market Account It offers 1.85% interest and doesn’t charge any fees.  You can open an account with a $100 minimum.
  2. Sign up for a FREE Personal Capital account to start tracking your net worth, monthly spending et.
  3. Start saving and investing your spare change automatically with Acorns.  Acorns is an app that takes your spare change and doesn’t just set it aside for you, but rather it invests it for you using a method called “micro-investing.”

Be sure to read our Comprehensive Guide to Early Retirement

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Have a great day

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