What is the 4% Rule?

A key aspect of retirement planning is knowing how much to save. Another major component is knowing how much to spend during retirement. Overspending can lead to your retirement savings depleting. To avoid this scenarios, some investors adopt what’s called the 4% withdrawal rule. While it isn’t absolute, the 4% rule is a baseline for how much to spend annually during retirement.

What is the 4% Withdrawal Rule?

The 4% withdrawal rule says an investor should be able to live off of 4% of their savings during their retirement. The hope is that by following the 4% rule, an individual can live off of their retirement savings for more than 30 years.

To arrive at your 4%, add up all of your investments and then calculate 4% of that sum. It’s important to keep in mind that 4% is a rule of thumb and it won’t apply to every person’s circumstances.

As an example, imagine you retired with $2 million tucked away in investment accounts. 4% of that number during your first year of retirement would be $80,000.

Exceptions to The 4% Rule

• A portfolio not performing well one or more years: Some years, a portfolio may not perform as expected and this could mean lower returns than anticipated. As a result, a retiree may have to exceed 4% of spending for the year. Thorough financial planning can help avoid this outcome, but sometimes there is no choice but to withdraw more than 4%. In that case, the retiree might consider reducing their spending in the following years.
• There’s a notable change in expenses: Sudden increases in the cost of living, such as having to pay more for accommodation and groceries, moving to a more expensive city, or changes in health, can result in increased expenses.
• Life expectancy: There’s a possibility a retiree could live well beyond 30 years. If so, they may need to live on less than 4% to ensure their portfolio is sustainable.
• Taxes and fees: Depending on the type of account funds are saved in, retirees may have to pay taxes on withdrawals. Drastic changes in tax laws could mean having to withdraw more than 4% to cover expenses.

The 4% Rule and Social Security

There are concerns that social security funds may run out in coming years. Since the 4% rule factors in social security savings, in the event that funds do run out, it could affect how much a retiree has available to live off. Without social security benefits to pull from, retirees would have to withdraw more from their investments in a 401(k), IRA, or a standard brokerage account.

The 4% rule can make it easier to plan for withdrawals in retirement. However, fine details matter, so consider some of the mentioned scenarios and factor them into your retirement plan. To ensure you’re putting enough away for retirement, use a retirement savings calculator to put the numbers into perspective. Also, consider the type of lifestyle you want to live during retirement and let that guide your savings goal.

If you’re still unsure about the right number for your situation, reach out to one of our finance advisors today.