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One long-standing guideline in retirement planning is the 4% rule: withdraw 4% of your retirement portfolio in the first year and adjust that amount for inflation each year. The idea is that, assuming an average portfolio return around 7% and inflation near 3%, a 4% withdrawal rate should let your money last indefinitely.
To estimate how large your nest egg needs to be, divide your annual spending need by 0.04. For example, $40,000 a year requires $1 million; $50,000 a year requires $1.25 million.
But the 4% rule rests on several assumptions that don’t always hold:
– Steady returns and sequence risk: The rule assumes consistent long-term returns, but markets vary. Poor returns in the first few years of retirement can force you to take principal withdrawals when your portfolio is down, reducing future growth. Research shows early negative returns can require lower withdrawals later to avoid running out of money.
– Stable expenses: The rule assumes your spending stays roughly the same, adjusted for average inflation. In reality, costs—especially medical expenses—may rise faster than expected, and higher spending during market downturns can be especially damaging.
– Fixed taxes: The rule treats taxes as a known, steady cost. Tax rates and your tax situation can change in retirement, leading to higher-than-expected tax bills and the need to cut spending or withdraw more from principal.
Because of these limitations, some experts advise shifting the focus from hitting a single “magic number” to managing retirement cash flow. That means looking at all your assets and potential income sources—savings, investments, pensions, Social Security, annuities—and comparing predictable income to expected expenses. If income is short, you can plan to boost it or reduce costs rather than rely solely on a fixed withdrawal percentage.
Final practical point: while you may receive some Social Security or other steady income in retirement, much of your future income depends on saving and investing now. Save aggressively, invest thoughtfully, and consider building additional income streams to help support you through retirement.
