The 4% Rule: Live off Your Money Forever

The 4 percent rule is a rule of thumb that many individuals use as part of their retirement planning. This is a rule that is designed to help you determine how much money you should take out of your retirement portfolio every year. Here are a few things to consider about the 4 percent rule and how it works. 

What is the Purpose of the 4 Percent Rule?

Many people do not know how much money they need to take out of their retirement portfolios. They want to take out enough to live on, but at the same time, they are worried that they will outlive their retirement dollars. If you take out too much money early on, it can be very difficult to live comfortably later in life. The 4 percent rule is going to help you decide how much money to take out without completely depleting your account for the future.

How it Works

Applying the 4 percent rule is actually very simple. In order to make this rule work, you are going to take out 4 percent of the available funds in your retirement portfolio in the first year of your retirement. The second year, you are going to take up the same dollar amount as you did in the first year, except that you are going to add for inflation. If there was 2 percent inflation over the course of year, you would add 2 percent to that dollar figure. It is important that you realize that you are adding 2 percent to the dollar figure, and not to the percentage. You do not want to take out 6 percent of your portfolio. 

Example

Let's say that you had $1 million in your retirement portfolio. According to the 4 percent rule, you are going to take out 4 percent of $1 million in your first year. That would come to a total of $40,000. The next year, you see that there was 3 percent inflation over the course of the year. This means that you are going to add 3 percent to that $40,000 number. This comes out to another $1200 that you are going to take out for inflation. In the second year, you are going to take out a total of $41,200 from your retirement account. The third year, you are going to take out $41,200 plus the percentage for inflation. You are going to continue doing this for the rest of your life. 

Time Frame

As a general rule, this guideline should only be used if you are planning on using your money for about 25 years. If you are 90 when you retire, then you could most likely take out a greater percentage. If you are retiring early, you may want to take out even less. As long as you plan on allowing your funds to last for 25 years you should be fine.

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