Retirement Reality Check: What Does the Four Percent Rule Mean for You?
by , CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
April 18, 2012
My husband and I are both turning 50 next year, and trying to figure out how much we have to save for our retirement. I've read that we can only withdraw about four percent of our portfolio a year once we're retired, but that seems out of reach. I'm trying not to panic, but don't know what to do. Can you offer any suggestions?
You're certainly not alone in your concern about how much to save for retirement. According to the 2011 Retirement Confidence Survey conducted by the Employee Benefit Research Institute, only 24 percent of respondents say they're very
confident that they'll have enough money for a comfortable retirement; 17 percent say they're not at all
confident. On top of that, more than half of workers say they have less than $25,000 in total savings.
These are disturbing statistics that suggest a definite need for guidance in calculating retirement saving and spending—as well as some real counseling in how to save more. So you're smart to be giving this serious thought now while you still have many work years ahead. Here are some things to consider.
Figure out what the four percent rule means for you
The guideline says that you can withdraw four percent of your portfolio's value in your first year of retirement, and increase that amount every year for inflation. It assumes that you have a conservative to moderate portfolio (20-60 percent in stocks) and will have a 30-year retirement.
So what does that mean in reality? First do a rough estimate of how much you'll need to live on in retirement. An easy way is to just base it on what your expenses are today. Now subtract estimated Social Security benefits and any other non-portfolio sources of income.
Let's say that you and your husband expect to spend $65,000 the first year in retirement and anticipate $30,000 in combined Social Security benefits. If you have no other sources of income, you'll have to withdraw $35,000 from your portfolio to meet your income needs. Now multiply that figure by 25 to come up with your target retirement portfolio. In this case, you'd need to aim for a portfolio of $875,000 to be able to follow the four percent rule.
Remember, it's a guideline not an absolute
While the four percent rule is a useful predictor of retirement success, it's not set in stone. For instance, might your retirement be longer? Withdraw less. If you think it will be shorter, you can consider increasing your withdrawal by a small amount.
Your risk tolerance is another factor. The four percent guideline is designed to provide a 90 percent certainty that you won't outlive your money. If you're comfortable with a lower confidence level, say 80 percent, you might withdraw up to five percent.
Be realistic about retirement
Guidelines aside, you have to be realistic in your retirement expectations—and flexible. Do you plan to stop working completely at a certain age? What's your target date? Do you need to extend it? More and more people are planning to work into their late sixties or seventies. And a lot of retirees have found that working part-time keeps them happy, engaged—and on budget.
What kind of lifestyle do you want? Do you envision a lot of travel and entertainment or do you plan to slow down? Many retirees actually find that their lifestyle is more costly in the early part of their retirement while they're more active. But if you're confident that you'll spend less as you age (health care costs notwithstanding), you can budget—and adjust the draw on your portfolio—accordingly. Conversely, if the stock market has an extended downturn, withdrawing less will provide you with some extra cushion.
Save as much as you can
While having a portfolio large enough to follow the four percent rule and cover your needs may seem out of reach now, don't panic. Instead make a commitment to use every possible means to increase your savings. Here are some ideas:
- Take advantage of the catch-up contribution in your 401(k)s and IRAs when you both turn 50.
- When you get a raise, save it in a personal taxable account or increase the percentage you put in your 401(k).
- Put all or part of an annual bonus toward your retirement.
- Invest your tax refund in your IRA.
Finally, to help yourself feel more in control, either consult with a financial planner or go to an online calculator to explore different retirement savings scenarios. You might be amazed at how much difference a few extra dollars and a few extra years of saving can make.
The information on this website is for educational purposes only. It is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.