There is something called the 4% rule that is very helpful with retirement planning and goal estimation. What is the 4% rule? Should you use it in your financial planning? Let’s explore the topic a bit further…

## What is the 4% rule?

The 4% rule was developed in the mid-1990s. A study was done looking at the past performance of a diversified investment portfolio to determine how much could be withdrawn each year while maintaining a high likelihood that the money would last at least 30 years.

### Why 30 years?

With the average retirement age in American being 62, this would put someone into their early 90s – which is a bit older than the current average life expectancy.

### Just HOW likely is the money to last?

At the time the study was done – more than 20 years ago now – there was about a 95% chance that the investor would never run out of money.

### Is it always 4% of your balance?

Actually, no, it isn’t. The official guidelines of the rule state to take 4% of your balance in year one of retirement. In year two take the amount of year one but increase it by the current inflation rate. Then keep adjusting each year, using the previous year’s withdraw as the starting point. So if you withdraw $10,000 one year, then inflation over the year is 2%, you would withdraw $10,200 the next year.

### How is the 4% rule useful?

Assuming you trust the 4% rule today (more on this below), you can **estimate how much money you can draw in retirement with minimal risk of running out**.

Say you have $500,000 in investments when you retire. Using the 4% rule you could estimate your ability to withdraw $20,000 the first year, and then slightly increasing amounts each consecutive year.

You can also work the numbers backward. If you are going to follow the 4% rule in retirement, then you can use this to estimate the total retirement investment balance you’ll need. The easy way to calculate this is to take the annual amount you hope to withdraw and multiply it by 25.

**Example**: If you want $50,000 per year of retirement withdraws (adjusted moving forward for inflation), then you would likely need around $1,250,000 in investments. $50,000 x 25 = $1,250,000. If you don’t believe that simple math, just double-check it: $1,250,000 x 4% = $50,000. There you go.

## Don’t forget Social Security and other benefits

Just a quick note here because often people forget: The **retirement withdraws should be the difference what you budget to live on and what retirement benefits you’ll receive.**

If you estimate you will need $50,000 to live, and your social security estimation shows you’ll get $24,000 a year in benefits, you’ll only need to draw about $26,000 from investments. Don’t have any idea what you might get from Social Security? **Here’s a walkthrough showing how to check your Social Security records and estimate your benefits.** It’s easy. Go do it now.

Same deal if you have a pension or other source of income during retirement. **Drawdowns of your investment accounts only need to cover the shortfall of other benefits.**

Don’t forget this because it can have a huge impact on both your planning and your spending later in life.

## How does the 4% rule look with recent market performance?

The 4% rule still looks pretty good actually – at least as a starting point to help get some estimated numbers for your savings goals.

While this rule gave about a 95% success rate in the mid-90s, the success rate has dropped a bit in recent years. Depending on how the market performs, we might get closer than that 95% – or a bit further away. That’s why this is just an estimation tool.

Looking at recent performance, using the 4% rule today would give about a 90% chance of never running out of money over 30 years of retirement. Honestly, that’s a still pretty good percentage! In fact, based on recent performance, **about two-thirds of people using the 4% rule will have more than their starting balance still even after 30 years**. Because of this, some people say the rule is too conservative.

## Increasing the odds

Is there really such a thing as too conservative though? Yeah, I suppose there is.

Let’s say you aren’t “too conservative” but you would like a bit better odds than 90%.

Adjusting your expectations down to **a 3.5% withdrawal level increases your success chances back to around 95%**. In fact, you would even have a 92% chance of the money lasting more than 40 years at that rate, and an 88% chance of it lasting 50 years! Hmm. Early-retirement maybe?

Dropping down to a 3% withdraw rate increases the odds of success by two more percentage points to 97%.

## But let’s be reasonable

At some point though you have to **balance reasonable risk**.

While some people might say “Okay, I’ll just use 3% as my estimator”, you need to consider the impact on the numbers.

If you want $50,000 of retirement income, you would need $1.25 million estimated using the 4% rule.

If you go conservative and use 3% instead, you’ll want to target almost $1.7 million. *That’s 33% more money required to achieve your goal*. If you can do that – GREAT. But if that starts to seem unreasonable, it’s okay to assume a small amount of risk. **90% odds really are pretty good!**

## Stretching out the dollars

Something else to consider: **You’re in charge of your spending!** Well, if you are managing your cash flow with a budget then you are.

Say you follow the 4% rule and you’r