Calculating the 4% rule involves determining a sustainable amount you can withdraw from your retirement savings each year without running out of money over a typical retirement period.
Here's how to calculate it based on the reference:
The Basic Calculation
The core idea is to calculate 4% of your total investable assets at the start of retirement. This amount becomes your withdrawal budget for the first year.
- Step 1: Add up all your investments, retirement accounts, and any residual income streams that function like an asset pool (as mentioned in the reference).
- Step 2: Calculate 4% of this total sum.
- Step 3: This calculated amount is your maximum withdrawal for your first year of retirement.
- Step 4: In subsequent years, adjust your withdrawal amount from the previous year based on the rate of inflation.
Detailed Steps
Below is a breakdown of the calculation process:
| Step | Action | Description |
|---|---|---|
| 1 | Total Your Assets | Sum the value of all investment accounts, retirement funds (like 401(k)s, IRAs), and relevant income-producing assets. |
| 2 | Calculate 4% of Total | Multiply the total asset value from Step 1 by 0.04 (which is 4%). |
| 3 | Determine First Year's Withdrawal | The result from Step 2 is the amount you can withdraw in your first year of retirement. |
| 4 | Adjust Annually for Inflation | For each subsequent year, increase the previous year's withdrawal amount by the current inflation rate. |
Example Calculation
Let's say you have the following assets at the start of retirement:
- 401(k): $800,000
- IRA: $150,000
- Taxable Investment Account: $50,000
- Residual Income (like value of rental property contributing to asset base): $0 (for this example)
- Total Assets: $800,000 + $150,000 + $50,000 + $0 = $1,000,000
- Calculate 4%: $1,000,000 * 0.04 = $40,000
Your calculated withdrawal for the first year of retirement is $40,000.
For the second year, if inflation was 3%, you would withdraw $40,000 * (1 + 0.03) = $41,200. This adjustment continues every year.
Important Considerations
- The 4% rule is based on historical market data and designed to make your savings last typically 30 years.
- It assumes a diversified investment portfolio.
- Adjusting for inflation helps maintain your purchasing power throughout retirement.
- Some variations of the rule exist, using slightly different percentages or adjustment methods.
