Finance

The 4% Rule: How Much Should You Be Setting Aside for Retirement?

The 4% Rule: How Much Should You Be Setting Aside for Retirement?

Calculating how much you need to set aside to comfortably retire should be a key part of your long-term financial plans. Enjoying a happy retirement has a lot to do with knowing that you will be financially secure when you’re ready to stop working. Retirement is a careful balancing act between what you will need to spend day-to-day, large purchases or “bucket list” plans, and what you may want to preserve to pass on.

In an ideal world, people planning for their retirement make sage, careful calculations to understand what their needs will be. Unfortunately, many retirees use simplified rules to guesstimate how much they’ll need to take out each year. What this often results in is much of their wealth still being in the bank and ending up being passed along to their beneficiaries. While there’s no harm in leaving behind more for your loved ones, you’ve worked long and hard for that money. So there’s also no harm in finding ways to enjoy more of what you’ve accumulated while still preserving some for future generations. So how do you do it? It’s not with guessing. 

The 4% rule

The popular 4% rule works like this: you can withdraw 4% of your portfolio every year you’re retired without facing a substantial risk that you’ll run out of money. For example, if you have $100,000, then you’d be able to withdraw $4,000 a year. This rule is based on sound academic research, but that still doesn’t mean it’s the best option for you. This research used a “set it and forget” model and didn’t account for behavior adjustments over time. Basically, it’s based on your retirement withdrawals being set up at 25 and then never being changed.

Why doesn’t it work?

Barring a return to the Great Depression, people following the 4% are likely to leave a lot of money leftover in their bank accounts. The 4% rule is an incredibly conservative investment rule that doesn’t consider other sources of income and the timing of when each source starts. If you retire earlier than expected – say, before your Social Security or pension kicks in – you don’t necessarily need to scrimp by only taking out 4% of your retirement portfolio. It would make much more sense to withdraw more during this time, but a lot of retirees resist this. The popularized 4% rule of thumb has made them fearful they’ll run out of money if they don’t stick to the rule. Instead, having a customized withdrawal plan in place can actually help increase your odds of your savings lasting you longer.

Talking to a financial advisor is a great way to assess your financial potential, however, be wary of a financial advisor that only uses a rule of thumb to determine what amount you should withdraw. It’s fine for your younger years or to set broad, general expectations but when you’re reaching the point when you’re going to consider retiring in the next few years, it’s time to get rid of generalizations. 

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