While many banks, especially around RRSP season, will try to convince you to save as much as possible if you ever want to be able to retire. One simple way to decide for yourself what you’ll truly need to retire is the 4% rule. The 4% rule states that you can withdraw 4% of your investment portfolio in the first year, then adjust for inflation each year after that and not run out of money for 25-30 years. A portfolio of at least 50% bonds at retirement will reduce volatility and increase the odds of this general calculation being reliable .
One other thing to keep in mind is what you can expect from the Canada Pension Plan (CPP) and Old Age Security (OAS). While many things can effect the amount, including when you start withdrawing from the CPP, as well as OAS clawbacks based on income, a good average for a retired couple is $25,000 per year. Of course, if you have an employer pension you’re even closer to your target retirement income.
So lets say you want to have an income at retirement of $50,000. With a mortgage paid off and children out of the house, this is actually a pretty comfortable amount. As we’ve discussed, CCP and OAS will likely cover $25,000, leaving you with another $25,000 to fund yourself. You can calculate the 4% rule by taking the amount you need, in this case $25,000, and dividing by 4%. Using the 4% rule, you would need $625,000 at retirement.
Since the 4% rule also covers for inflation, the only time you ever take out 4% in the first year. There will be enough room for you to increase your withdrawal by the amount of inflation. So in the first year, you may have withdrawn $25,000. However, in the second year inflation may have increased 2%, so you would now take $25,500 out of your investments. You then continue to adjust your withdrawal amount each year with the rise of inflation.
While the 4% rule is a simple way to calculate for retirement, it may not work out that way in real life. Say for example, you retired in early 2008 and watched your portfolio lose 20-40% by the end of the year, you would then need to adjust to a lower withdrawal rate to continue your retirement. This is why you should consider having the majority of your portfolio in bonds at retirement as it might help reduce the odds of such a large loss.
How Much Do You Need To Retire? The 4% Rule,Related Posts:
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Of course, it is important to note that $50,000 at retirement might not be much if you plan to retire in 30 years.
In “How Long Will It Take To Double My Money? The Rule Of 72″ (http://canadianfinanceblog.com/2009/08/04/how-long-will-it-take-to-double-my-money-the-rule-of-72.htm), we can see that “a 3% inflation rate would mean your money will lose half it’s spending power in 24 years”
Don’t forget to factor that in.
William Bernstein and Jim Otar show pretty carefully that 3% is a more accurate rule of thumb, and even then you have to pay a great deal of attention to what is happening during the first decade of retirement.
Hmm, but presumably if you have most of your money in bonds though, neither 3% nor 4% is going to keep up with inflation over 30 years…
This sort of problem is why I prefer to target a growing income from dividends, bond coupons, cash interest, property etc, and let the capital take care of itself, rather than risk big drawdowns in bad years by funding withdrawal from selling assets.
To be able to retire on the 4% rule, you must get the 4% mostly from Multi National Stocks that increase dividends.
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I really like that 4% rule – I only have about 35 years left until I can retire
Max out your investments in dividend stocks or bonds if you must, to create a cash machine that will require no withdrawal of principal. Skip the growth stocks everbody is pushing cause they usually don’t. grow that is. If you buy a div stock and it goes down a bit, who cares as long as it continues to pay you regularly? Living within your income limit helps as well.
I agree with your 4% rule. However, if you are withdrawing money from your RRSP either before, or after you retire, you have to pay tax on that money. If you figure a modest tax rate of 30% then you really have to withdraw roughly $36,000.00 the first year. This throws off your formula. If you adjust your formula for taxes, the amount you would need in your retirement account would be, roughly $900,000.00 This begs the more important question; How much money does an average Canadian family have to put away over 30 years to get to $900,000.00? Even at a healthy compounding rate of 6% that works out to roughly $10,000 a year or $833.00 a month. Is this reasonable for the average Canadian?
I’m not sure that depending on a single income stream from your RRSP for your retirement is the best approach.