Thursday, 31 October 2019

How Much Should You Spend Annually In Retirement? 4% Rule & Safe Withdrawal

Planning for retirement

Today we're talking about how much you need in retirement. We will be talking about the 4% rule and also the safe withdrawal rate. If you're like me, you're probably thinking to yourself, I know I need to save for retirement, but how much, how much do I actually need?

The typical rule of thumb is 20 to 25 times your annual salary. When I say annual salary, that is what you want to earn in retirement. If you want to live off of $50,000 a year, that would be 25 X $50,000 = $1.25 million, which is what you need for your nest egg to be able to pay yourself $50,000 a year for 25-years. I hope it makes sense.

At this point, you're like, how the hell am I going to save up $1.25 million, and maybe you were thinking hey, I may need more or less than $50,000 a year to live on.

Again, this is personal finance, it's all personal to us, I'm able to live off of $50,000 based on where I live, if you live in a state where things are very expenses, you may need $150,000, this is all proportional. 

What we're going to be talking about is how to use the 4% rule so that we never have to go below our principal sitting in that retirement account.


What Is The 4% Rule?

Let's say that you have a 401k and you're about to retire. In this 401k you have $450,000 and you also open up a Roth IRA a few years ago because you've been reading roadtosuccesse.com article. And in that Roth IRA, you have $50,000. In both of these accounts, we have $500,000.


  • 401k = $450,000
  • Roth IRA = $50,000
  • In Accounts We Have = $500,000

The 4% rule is what dictates us to be able to take out 4% of whatever this $500,000 retirement accounts is, without touching the principal.

We're living off of 4% every year and that's getting replenished every year. So how is this getting replenished?

The stock market had done 6% to 10% historically in return, so think about it logically, if you have a retirement account and you're taking out 4% every year to live off of, you're actually going to make it up by the return in the market.

The 6% to 10% is greater than the 4% you're taking out, so not only are you living on that, you're actually making some money as well by the end of the year.

Let's Look At a Real Like Example

We're using this $500,000 that we've set aside, we've saved up for many years and we're ready to enjoy retirement.

If you take this $500,000 multiply it by 4%, that comes out to be $20,000, again, this is all personal, you may be able to live off of $20,000, you may need more. So you need to save more for retirement.


  • $500,000 X 4% = $20,000

However, this 4% again gives us a cushion to be able to take this money out, but still be able to live and not touch our principal payment. 

When you account for this $500,000, your subtracting $20,000 becomes $480,000

$500,000 subtracting $20,000 = $480,000

Let's say we took this $20,000 out on January 1st, 2020, we're taking out at the beginning of the year and one lump sum, normally, you wouldn't do that, you would take out the average of whatever you want and pay yourself monthly and live off of that.

I take $20,000 out all on January 1st, the remaining $480,000 has all of 2020 to grow, and realize the 6% to 10% growth that we've talked about.

If we take $480,000 times 1.06, the 6% growth in the market, this now becomes $508,800 by December 31st, 2020.


  • $480,000 X 1.06 = $508,800

I hope all this makes sense. I'm just trying to break it down without too much math.

Not only have we lived on those $20,000 a year, but our $480,000 is also actually grown to be $508,800 by the end of the year.


Inflations

We all know that inflation exists. We know that inflation is typically 2% to 3% per year. Now, with the 4% method you can actually afford to pay yourself a 2% raise every year, so how is this possible.

Let's Do The Math.

Let's say that the $508,800 that we have at the end of the year 2020 that we just figure out. And now we take the $20,000, that was 4% from last year, we multiply it by 1.02, that 2, is our 2% increase.


  • $20,000 X 1.02 = $20,400

We've now adjusted for inflation, we are no longer earning $20,000, we're earning $20,400.

Let's do the math on this

If you take the $508,800 minus the $20,400, basic math tell us that we have $488,400


  • $508,800 - $20,400 = $488,400

Now, $20,400 we've taken out on January 1st, 2021 and the remaining $488,400 has all this entire year to grow by that 6% to 10% that we talked about earlier. 

Even if you're taking out 2% more to give yourself a raise to hedge against inflation, This $488,400, and if you multiply that again by 1.06, that actually give your starting number for the next year. $517, 704 on December 1st, 2021.


  • $488,400 X 1.06 = $517, 704

You started with $500,000, you've lived to 2 years, you're given yourself a 2% raise and now your nest egg is actually grown by $17,704. 

You now see how powerful this 4% rule is, obviously this is accounting for 6% growth in the market every year.

There have been studies done and this has been numerous times. That over the course of 33 years, there has never been a big enough fluctuation in the market on this downside to eating up someone's entire principal, to eat up this entire $500, 000 that they start with.

Typically, when people go into retirement, let's call it their late 50s early, 60s, most of them don't outlast 33 years, so you're living off of your nest egg without ever touching your principal, I hope that makes sense.

If you extrapolated this $517, 704 in 30 years, we started on 2020, let's say it's the year 2050, this 517, 704, is actually like $700,700 if you keep earning 6% year over year.

Not only have you lived for those 30 years, but you've also never touched your principal, you've grown your money by $200,000 plus.



Conclusion

Now that I know this math, I'm probably to be conservative, I'll be taking out 4% to 5% a year with my safe withdraws rate using that 4% rule and I'm going to be buying Benzes, beamers, mansions, well, just kidding. 

That is something you can't do, you cannot take huge chunks and you have to be super disciplined so you really do have to live off of that 4%. That's the only caveat to this and obviously market conditions aside.

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