The 4% Rule

 

The 4% Rule is a popular guideline for retirement planning that helps determine how much you can safely withdraw from your retirement savings each year without running out of money over a 30-year retirement period. It suggests that retirees can withdraw 4% of their total retirement corpus in the first year of retirement and then adjust the amount each year for inflation. This approach is designed to ensure a balance between withdrawing enough to cover expenses and maintaining enough in the portfolio to last throughout retirement.

How the 4% Rule Works:

1. Initial Withdrawal: In the first year of retirement, you withdraw 4% of your total retirement savings. For example, if you have a retirement corpus of ₹1 crore, you would withdraw ₹4 lakh (4%) in the first year.
2. Adjust for Inflation: In each subsequent year, you adjust your withdrawal amount for inflation. If inflation is 3%, in the second year, you would increase your withdrawal by 3% to keep up with rising costs. In this case, you would withdraw ₹4.12 lakh (₹4 lakh + 3%).
3. Portfolio Allocation: The rule assumes that you are invested in a balanced portfolio, typically with 60% in stocks and 40% in bonds. This asset allocation gives the portfolio potential for growth while also providing some stability.

Example Calculation:

Let's say you have ₹2 crore saved for retirement. According to the 4% rule:

• In the first year of retirement, you would withdraw ₹8 lakh (4% of ₹2 crore).
• If inflation in the second year is 5%, you would withdraw ₹8.4 lakh (₹8 lakh + 5%) in the second year.
• You continue adjusting the withdrawal each year based on inflation.

Key Assumptions Behind the 4% Rule:

• 30-Year Retirement: The rule is based on the assumption that retirement will last for about 30 years. This works for someone retiring at 60 or 65 and expecting to live into their 90s.
• Balanced Portfolio: The 4% rule assumes that your investments will earn returns through a diversified portfolio. Historically, a 60/40 stock-bond portfolio has been able to support this withdrawal rate while balancing growth and risk.
• Historical Market Performance: The 4% rule is based on historical data of stock and bond market returns. It assumes that future returns will be similar to past performance.

Benefits of the 4% Rule:

• Simple to Follow: It provides a straightforward rule of thumb for retirees to know how much they can withdraw.
• Inflation Protection: By adjusting withdrawals each year for inflation, the rule ensures that your purchasing power remains stable over time.
• Low Risk of Running Out of Money: If followed properly, the 4% rule aims to reduce the risk of depleting your retirement savings prematurely.

Limitations of the 4% Rule:

1. Doesn't Consider Individual Factors: The rule doesn't account for personal factors like changing spending habits, health needs, or other financial obligations in retirement.
2. Market Volatility: During periods of significant market downturns, your portfolio may not grow as expected, potentially affecting the long-term sustainability of a 4% withdrawal.
3. Inflation Variability: While the rule adjusts for inflation, unpredictable spikes in inflation or long periods of low inflation may challenge the withdrawal strategy.
4. Longevity Risk: If you live longer than expected (e.g., beyond 30 years), you may need to rethink the withdrawal rate.

Adjusting the Rule:

While the 4% rule provides a basic guideline, some retirees may choose to adjust it:

• Lower Withdrawal Rates: Some financial planners suggest a lower withdrawal rate (e.g., 3-3.5%) for those who want to be more conservative and ensure their money lasts longer.
• Dynamic Withdrawals: A more flexible approach might involve adjusting withdrawals based on portfolio performance. If the market performs well, you might withdraw more; if it performs poorly, you withdraw less.

The 4% rule is a useful starting point, but it's important to tailor it to your personal retirement plan, taking into account factors like life expectancy, lifestyle goals, and market conditions.

Would you like help applying the 4% rule to your retirement plan, or do you need more specific calculations for your retirement corpus?