The 4% Rule answers a common retirement planning question – How much money do I need to retire?
It is known as a “safe withdrawal rate.”
Here’s how it works:
- Add up all your investments
- Multiply by .04
- The product is roughly how much you can spend each year from your nest egg adjusted for inflation
For example…
$600K x .04 = $24K per year above and beyond your pension and any social security you may receive
By following this formula, you have a very high probability of not outliving your lifestyle during a 30-year retirement. Some studies have found that an early retiree with a 40-50 year retirement ahead of them, may err on the side of a 3-3.5% safe withdrawal rate.
So how much money do I need to retire? It all depends on the expenses associated with your retirement lifestyle (AKA how much does it cost to be you!).
$84K retirement lifestyle
– $60K of pension/social security benefits
= $24K annual retirement income need from investments
Take your annual retirement income need and multiply by 25 to find approximately how much money you should have saved using a 4% safe withdrawal rate.
In this example…
$24K x 25 = a $600K nest egg
The concept of the 4% Rule is attributed to Bill Bengen, a financial academic who conducted his initial research in the 1990’s. Bengen concluded that, even during extremely volatile markets, no historical case existed in which a 4% annual withdrawal depleted a retirement portfolio in fewer than 33 years.
The rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976, concentrating on the severe market downturns of the Great Depression and the early 1970s. Numerous studies in recent years have validated the relatively conservative nature of a 4% safe withdrawal rate.
Bengen found an appropriate allocation should contain at least 50% stocks to support portfolio growth. In many cases, a 4% safe withdrawal rate had a large probability of leaving more than 100% of the original starting balance at the retiree’s passing.
It all starts by getting a pulse on your annual expenses. Some firefighter retirees can cover their annual expenses with the pension alone. In that case, they may not need to pull money from their nest egg year-to-year. Instead, they can leave it invested as their “flexibility fund.”
One year, they may pull from their flexibility fund for a nice vacation or to spoil grandkids. In another year, they may tap into it to handle an emergency like unforeseen medical expenses or home repairs. Either way, the math is relatively simple to determine how much money you should have saved at retirement. It’s never too early to start running the numbers and make sure you’re on track for the retirement you desire.
Chris Bauchle is a career firefighter with the Indianapolis (IN) Fire Department. He is a CERTIFIED FINANCIAL PLANNER™, holds a Master’s degree in Finance, and has served well over 100 firefighter families as a financial advisor.
More educational content can be found at firefighterfinancialadvisor.com, where you can subscribe to his quarterly newsletter and be notified of future Firefighter Nation articles.
