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What Is The 4% Rule?
The 4% rule is the concept that a person can withdraw 4% of his savings each year without depleting his principal over the long term. Said differently, by withdrawing no more than 4% of your savings, statistically you can expect the balance to last 30+ years and provide a comfortable retirement.
The 4% Rule Calculation
Say Sherry and Jim have savings of $500,000. If you multiply 4% by $500,000 you get $20,000. Sherry and Jim can comfortably retire if they spend no more than $20,000 per year. This is assuming no other income from social security, a pension, etc. If you were to receive $1,000 a month from social security you can factor this in and adjust your calculation to spend no more than $32,000 per year ($20,000 + $12,000).
The 4% Rule and the FIRE Movement
The 4% rule is often talked about by people who want financial independence, retire early (FIRE). It informs what you need to save to retire so that you can largely life off of interest and dividends. How does this work?
Let’s say Jack’s monthly burn rate is $2,500 (this means Jack needs $2,500 for all living expenses). Let’s do the math to see how much Jack needs to save to be able to FIRE.
- Calculate annual burn rate: $2,500 per month equals $30,000
- Divide annual burn rate by 4%: $30,000 / 4% = $750,000
Jack would need $750,000 to retire early.
The 3% Rule
The 4% rule is most commonly used in the FIRE community and by many financial planners. If you are more conservative you may wish to use 3% instead of 4%. In the case of a major market downturn or a long life expectancy you many find 3% provides extra buffer.