The 4% rule is a common rule of thumb. As an example, assume you retired with an investment portfolio totaling $750,000. With this rule, you would be able to spend $2,500 per month without running out of money. This is the amount you could spend during the first year of retirement. In subsequent years, you would adjust the spending amount to adjust for inflation. This rule assumes you withdraw the same amount each year and reduce your spending to adjust for inflation. This certainly is a reasonable place to start, but it doesn’t fit all situations.
This rule assumes that you don’t make unscheduled withdrawals. It would be wise to NOT invest all your retirement funds but to leave some of this money in a money market-type account to utilize for potential emergencies. This rule also assumes that 50% of your money is invested in a bond fund and 50% in the stock market. This portfolio might not work well for someone who is more aggressive or for someone who is less aggressive.
This rule also assumes a 30-year time horizon. Assuming your time horizon is less (assume you are age 70), you can be more aggressive and take a larger percent of the investment as your life expectancy is not as long as a younger person, say age 55. How long your retirement funds last is a function of the length of time during retirement, how you are invested, and the percent of the investment funds you withdraw. Assuming you plan on 30 years in retirement, and you invest 60% in stocks and 40% in bonds, a 4% withdrawal rate should last at least 80% of the time. The converse is that there is a 20% chance it will NOT last 30 years. This data was obtained from T. Rowe Price. Assuming you reduce the withdrawal rate to 3%, there is a 95% chance that you will NOT outlive your money.
What is important to remember is that the above rule works no matter how much money you start with. If you would like to learn more about withdrawal rates, please contact us at 305-607-7088.