The Four Percent Rule is the original Safe Withdrawal Rate strategy. In short, the strategy is based upon withdrawing an inflation adjusted 4% of the portfolio's initial value each year in hopes that the rest of the portfolio will continue to grow at a rate that would compensate for the amount withdrawn.
The core purpose of the Four Percent Rule is to set up a system where you can withdraw consistent amounts of money from your savings without depleting your investments throughout the full length of your retirement.
If you plan on living off of your savings accounts as your primary means of cash during your retirement years, then you need to make sure that you have a plan in place that doesn't wipe out your savings too quickly. That is where the Four Percent Rule comes in.
By taking 4% out at the beginning of each year as your salary to fund your living expenses, the hope is that the investments in the market would be able to recoup the amount withdrawn and maybe even grow beyond the initial balance.
After all, a conservative average of stock market returns over long periods of time ranges between 5-8% growth per year. So, if you are only taking out 4% each year, your overall portfolio actually has a good chance of increasing over time. This increase allow you to positively adjust your withdrawals based off of inflation (as discussed below) and gives you some wiggle room in case you begin your retirement right before a period of negative stock market performance.
The Four Percent Rule provides a very simple calculation for figuring out how much money you need to save in order to reach your target budget.
Simply multiply your target budget by 25.
For example if you wanted to have a budget of $40,000 per year, multiply $40,000 by 25 to get your savings goal of $1,000,000. A seven-figure number may seem high, but remember that once you reach that figure and start putting the plan into place, you could live off of your budget and may never have to work again.
Some more examples of common budgets are below:
| Target Budget | Savings Required |
|---|---|
| $20,000 | $500,000 |
| $25,000 | $625,000 |
| $30,000 | $750,000 |
| $40,000 | $1,000,000 |
| $50,000 | $1,250,000 |
| $75,000 | $1,875,000 |
| $100,000 | $2,500,000 |
| $125,000 | $3,125,000 |
| $150,000 | $3,750,000 |
Keep in mind that if you decide to increase your withdrawals in line with the rate of inflation, your budget will be growing each year along with the inflation rate. This means that the dollar figure of your budget could be twice as much after 25 years.
Tax Advantages
Another tip to keep in mind when planning how much you need to save is that Safe Withdrawal Rate income is taxed very differently than regular earned income from your job.
The earned income from your job could be taxed as high as 30%-50% depending on where you live and how much you make.
On the other hand, your taxes on your withdrawals in a SWR plan are often times completely tax free!
So if your $100,000/yr job has income taxed at 30%, that means that your yearly budget is really only $70,000 even though you would consider yourself as having a 7-figure job.
Here is where this works to your advantage. Instead of needing to save $2,500,000 to fund a $100,000/yr lifestyle, you really only need to save $1,750,000 to fund your current $70,000/yr lifestyle. That is a difference of $750,000 less that you have to save by leveraging the tax advantages of the a Safe Withdrawal Rate strategy.
This is the most important question to ask because you need to ensure that your retirement savings will outlast the amount of time that you will be withdrawing from it.
The following chart shows the success rate of how this strategy would have fared across real historical time periods:
| Durations | ||||||
| 20 years | 30 years | 40 years | 50 years | 60 years | ||
|---|---|---|---|---|---|---|
| Withdrawal Rates | 3% | 100% 83/83 | 100% 73/73 | 100% 63/63 | 100% 53/53 | 100% 43/43 |
| 3.5% | 100% 83/83 | 100% 73/73 | 100% 63/63 | 96% 51/53 | 98% 42/43 | |
| 4% | 100% 83/83 | 100% 73/73 | 89% 56/63 | 75% 40/53 | 74% 32/43 | |
| 4.5% | 100% 83/83 | 89% 65/73 | 67% 42/63 | 49% 26/53 | 56% 24/43 | |
| 5% | 100% 83/83 | 71% 52/73 | 51% 32/63 | 36% 19/53 | 37% 16/43 | |
Many people use the Four Percent Rule as a way to enter retirement early with a potentially perpetual income stream from the savings.
Theoretically, this strategy could provide you with yearly income that never runs dry, as long as the stock market continues to perform close to its historical average.
(Note of caution: The promise of a never ending flow of cash for no extra work is an incredibly exciting possibility, but it is also important to plan in some wiggle room in case the market under performs for a significant amount of time.)
One way to mark the progress towards your early retirement when using the Four Percent Rule is to track what your yearly budget would be if you were to retire today.
You can track what your budget would be if you retired today by taking your investment portfolio and multiplying it by 0.04 (4%) or dividing by 25.
For example, if you currently have $300,000 in savings, you would divide that number by 25 (or multiply by 0.04) which would give you a yearly budget of $12,000. Many people would want a much more comfortable budget than that, but it gives you a precise figure for knowing what you would have to live off of today, if all other income streams stopped.
This is all in addition to any other income streams you might have. So, if you are old enough to start taking social security, then the withdrawals from your portfolio would be a bonus on top of your social security checks. So, if you were bringing in $24,000 from your social security checks, and the $12,000 from above, then the amount that you withdraw from this plan is extra money on top.
Even if you use a Safe Withdrawal Rate strategy to retire early, any additional retirement income such as social security or pensions, will eventually kick in at a later date to juice up your yearly budget even more.
If you are very diligent to retire early, then every dollar you throw at your savings can incredibly speed up your how quickly you can retire.
Lets say you want a budget of $40,000 in retirement and are starting with $200,000 in savings. If you had a high paying job where you could put away $100,000 per year, then it would only take you 8 more years to accumulate $1,000,000 in savings, which would provide for a retirement of $40,000 when utilizing a 4% withdrawal rate.
In fact, over that time period, your investments might actually increase in value, which could speed up your time even more. For example, after three years of this savings plan you have now accumulated $500,000, and if the stock market popped 20% that year (which has happened dozens of times), your portfolio would organically grow $100,000. This alone would cut an entire year off of your plan and allow you to retire one year earlier than originally planned.
In order to put your savings in the best possible position to continue to fund your retirement, it is important to allocation your investments throughout a diversified portfolio.
Possibly the most important component of a safe withdrawal rate portfolio is to make sure that your savings are invested in a diversified ETF or mutual fund that owns a plethora of publicly traded companies.
If you put all of your eggs in one stock, then all it takes to lose your life savings is for that one company to run out of business. On the other hand, an ETF, like VTI that owns over 3,800 companies could afford to have lots of its companies run out of business and still be in a healthy position.
You want to be diversified with you retirement portfolio, because most people will being relying off of it for their living expenses and, therefore, can not afford for it to be wiped out in one fell swoop.
Example Portfolio #1 (Balanced)
50% Stocks (SPTM, VTI, or VOO)
50% Bonds (VGIT or BND)
Note: This is the prototypical portfolio for the Four Percent Rule.
Example Portfolio #2 (Growth)
80% Stocks (SPTM, VTI, or VOO)
20% Bonds (VGIT or BND)
Note: This will give you the largest upside to grow your portfolio higher, but it also has the chance to drop a lot lower if the market hits a rough patch.
Example Portfolio #3 (Defensive)
25% Stocks (SPTM, VTI, or VOO)
75% Bonds (VGIT or BND)
Note: This strategy will allow you to defend against a big equity market downturn by placing the bulk of your investments in less risky bonds, but it could slowly eat away at your portfolio over time if the bond returns are not enough to recoup the amounts being withdrawn each year.
For many reasons, inflation is the most nefarious tax that a government can impose on its population. Fiscally, responsible citizens will need to take inflation into account as they begin to plan their retirement philosophy.
Having year after year of inflation means that goods and services generally become more expensive over time. That means that $40,000 can buy you more things in the first year of your retirement that $40,000 can buy you in the 20th year of your retirement.
If you don't increase your yearly withdrawals and keep it at a flat $40,000, then you will have the same yearly budget, but you will be able to buy less and less things each year as they get more expensive.
In order to prevent that loss of buying power throughout your retirement, the Four Percent Rule takes inflation into account. It does this by increasing your yearly withdrawal amount by the rate of inflation from the previous year.
For example, if you enter retirement with $1,000,000 and plan to utilize the 4% Rule you would withdraw $40,000 in your first year of retirement. When the second year comes around, you would then take the inflation rate from year one (let's assume 2%, for example) and then add that 2% to the $40,000 to get a $40,800 withdrawal budget for year two. This will give your money the same buying power in year 2 as the year before. You would continue to do this throughout the life of your retirement in order to maintain the same buying power as when you first entered retirement.
If inflation is a very serious issue for you, then consider utilizing the Inflation Buster technique as your Safe Withdrawal Rate strategy.
Before we dive into some examples of how the 4% Rule plays out, we can get a deeper understanding of the strategy by examining its origins.
When the Four Percent Rule was originally concocted, the team behind the strategy was initially trying to help give people a strategy to use in their retirement years to make sure that their investments would last throughout a 30 year retirement. Since then, however, people have tried to use these principles in order to think of the four percent rule as an effective strategy to live off of the portfolio in perpetuity.
The theory behind the Four Percent Rule goes back to the financial research team for the Trinity Study which concluded that a balanced portfolio would be able to survive a 30 year retirement by only withdrawing four percent of the original portfolio's value per year.
It is worth discussing some of the assumptions that the research team made in the pursuit of this discovery so that we can better understand how to tailor it to our specific needs.
Assumption #1 (30 year outlook)
They were only planning on a 30 year outlook in order to help people in their older retirement years (60 to 70 years old) prepare to live off their savings for another 30 years.
This is important to keep in mind for adherents of the FIRE movements (Financial Independence Retire Early) who want to be able to live off of their savings for many more years. For example, someone who wants to retire early, in their 30s or 40s, might need to plan for a 70 to 80 year retirement. Therefore, people with a goal to retire early might want to go with a lower withdrawal rate, such as 3.5%, 3%, or even 2.75% in order to give their portfolio the best chance of surviving for decades and decades to come.
If you lower your withdrawal rate and end up with more money in your portfolio than you planned, you can always reset your plan and raise your rate at a later date as you get older in age and have a shorter time horizon.
Assumption #2 (Historical Bond Performance)
When the study was originally conducted, the bond market had a better historical average than we have seen in the years since. If you base your plan off of old bond performance averages, then the conservative part of your portfolio could be putting a drag on your returns.
Some people have recommended offsetting this by placing a higher amount of your portfolio into the stocks and equities portion in order to capture more of the growth in the stock market and feed that growth into their savings. The statistics have shown that an equity heavy SWR portfolio could be promising, but it is important for people to know that this could be increasing your risk of big draw downs as well.
Assumption #3 (Steady Inflation)
People planning for retirement will often forget to take inflation into account. Thankfully the Trinity Study did not forget.
That being said, the United States has not seen many periods of hyper inflation, and therefore, sticking to this strategy (namely, tracking inflation) in a hyper inflation environment might not follow the intended results. Therefore, it is important to adjust accordingly when major market events are changing the landscape.
The goal of the Four Percent Rule is to withdraw money from your nest egg without having your savings deplete before the end of your retirement.
So, the first thing you will want to do is figure out how much money you want to spend per year in retirement. Let's say you want to spend $80,000 per year. The means that you will need to save up $2,000,000. This is because $80,000 is 4% of $2,000,000. You could have determined this by multiplying your budget of $80,000 by 25.
Once you know how much you need to save, you should evaluate your current situation to determine how long it will take to save that much money. If it is too much to save, then you will need to lower your yearly retirement budget in order to get to a more practical savings goal.
Once you have saved to your goal, $2,000,000 in this example, you will then be free to begin your Four Percent Rule retirement journey.
In the first year, you will withdraw $80,000 as your yearly budget. At the end of the year, you will need to find the inflation rate of the first year so that your second year's withdrawal maintains the same purchasing power as the first year. The inflation data (CPI-U) can be found on our historical inflation rates page.
If the inflation rate for year 1 was 2.78%, then you would increase your budget for Year 2 by increasing your previous withdrawal by 2.78% (so, $80,000 x 1.0278) which equals $82,224.
You would continue this process every year as follows throughout the length of your retirement:
| Year | Withdrawal | Notes |
|---|---|---|
| 1 | $80,000 | 4% of your $2,000,000 starting portfolio |
| 2 | $82,224 | Base of $80,000 multiplied by 1.0278 (2.78% inflation) |
| 3 | $84,789 | $82,224 multiplied by 1.0312 (3.12% inflation) |
| 4 | $87,027 | $84,789 multiplied by 1.0264 (2.64% inflation) |
Please note that you should closely monitor your portfolio balance. If the portfolio dips in the first few years, you should reevaluate your strategy. Early dips are the biggest threats to the Four Percent Rule. If you portfolio balance drops well below your starting balance, you risk depleting it quicker than intended. It would be wise to cut your withdrawals by either resetting the Four Percent Rule at your new, lower balance, or resetting with a lower withdrawal rate.
In many cases, however, your portfolio balance will actually begin to increase. In this case, you can rest easy knowing that your growing portfolio will more likely be able to withstand market dips in the future without having to impact your withdrawal amounts.
If you don't want to keep up with the government posted inflation rates over and over again every year, then you could take a simplified approach where you make the decision up front and then ride with your decision over the years to come.
This set it and forget it approach means you select a flat rate of inflation and simply stick to it.
Historically, inflation in the United States typically bounces between 2-4% per year, so you could simply say that you will go with a flat rate of 3%.
This allows you to spend less time adjusting your withdrawal amounts every year, and allows you to forecast a more consistent and smooth budget.
So, lets say you start with $1,000,000 in your savings portfolio and decide to increase your budget by a flat inflation rate of 3% each year. You will then be able to know your exact budget over the next 30 years:
| Year | Withdrawal | Notes |
|---|---|---|
| 1 | $40,000 | 4% of your $1,000,000 starting portfolio |
| 2 | $41,200 | Base of $40,000 multiplied by 1.03 for a flat 3% inflation rate |
| 3 | $42,436 | $41,200 x 1.03 |
| 4 | $43,709 | |
| 5 | $45,020 | |
| ... | ... | |
| 15 | $60,504 | |
| ... | ... | |
| 25 | $81,312 | Budget doubles after 25 years of 3% inflation |
| 26 | $83,751 | |
| 27 | $86,264 | |
| 28 | $88,852 | |
| 29 | $91,517 | |
| 30 | $94,263 | 30 years of increasing your budget by 3% each year |
No, there is no strategy that guarantees that you won't run out of money. However, the purpose of the strategy is to set you up in a position that significantly decreases your chances of running out of money. If you want a more conservative version of this strategy, then consider using the Three Percent Rule.
You can always combine any Safe Withdrawal Strategy on our site with additional income sources. For example, you could add the full 4% withdrawal on top of the Social Security income for your yearly budget, or you could use your Social Security income as your base and only add a smaller withdrawal amount in order to decrease the amount taken from your portfolio and give it a better chance of growing to a larger sum.
Yes. The best way on the entire internet to calculate your retirement plan is to use our Safe Withdrawal Rate Calculator.