The 4% Rule – Ensuring your Savings do not run out in Retirement
The 4% Rule
When we retire, our savings and investments will supplement any money received from private or government pensions. This raises the question; how fast should we deplete our savings if we want it to last until our death? There are many unknowns in the question, such as how many years of retirement before we die and what rate of return can be earned on our investments.
One answer to the question is known as the 4% rule and it was created by Bill Bengen who was a graduate of Massachusetts Institute of Technology. The 4% rule is a strategy for making sure you don’t wipe out your savings in retirement. If you withdraw 4% of your savings in each year of retirement, you have a 90% assurance that your savings will last at least 30 years. This model is based on the assumption individuals have a balanced portfolio and therefore should not be relied upon if the person has a 100% of their savings in guaranteed investment certificates.
There have changes in the investment world since the time Bengen devised the formula. For example, we have been a period of low-interest rates and it assumes linear withdrawals, but life is not linear.
The 4% rule should be considered a guideline, rather than an iron-fast rule. However, it will provide a formula for the rate of withdrawal of your savings and it will give an indication if you have sufficient savings. For example, if you have $10,000 in savings, a $400 annual withdrawal may not meet your needs.
Note – The actual formula has an inflation protection component which we are ignoring for this analysis. Bengen suggested the 4% should be increased each year by the rate of inflation.
