Planning Your Retirement With The 4% Rule

The mortgage is paid you have some investments, a pension pot and cash in the bank – so how much money a year do you think you can draw on to make life a little more comfortable in retirement?

The truth is no one really knows because they do not know how long they will live.

That’s why some investors like to take the safe route and guarantee a low income for life with an annuity rather than take a chance that the cash they do have will last as long as they do.

If you are around retirement age, you will also have seen some ups and downs in the stock markets and suspect that you are likely to see another.

Calculating how much you can draw from your pension and investments every year is a complicated calculation hampered by the variables of longevity and stock market volatility.

Topping up savings

That’s why financial advisers talk about the ‘4% Rule’ but even that has been downgraded in recent years from the 5% Rule.

What this rule says if someone aged 65 years old has saved £500,000, then they should have 4% of that amount to draw on each year without running out of money as their fund will replenish through stock market growth.

The 4% Rule is based on a 50-year study of Wall Street results by American economist William Bengen.

His workings showed that withdrawing 4% of a portfolio a year in cash would not have seen savings run out in less than 30 years under any stress test. The average was 33 years and in some cases, was as high as 50 years.

His analysis covered the Wall Street crash and Great Depression eras of the 1930s and 1940s, where stock values dropped by more than 60%.

How the 4% rule works

The 4% Rule helps retirement savers in two ways by running the calculation backwards and forwards to show how much money is available for drawdown or how much money you need to save to reach the required retirement sum to adequately fund those later years.

Going forward, simply take 4% of a retirement portfolio in the first year and adjust this upward by inflation each year and this should see the portfolio last a minimum 30 years.

Going backwards, calculate how much a year you expect to spend which exceeds the state pension.

For example, if that’s £20,000, then you need a pot of £20,000 x 25, according to Bengen, which is £500,000.


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