How Much Do You Need To Retire? The 4% Rule

How much do you need to retire? This is a thorny question that comes up regularly. Many consumers are unsure how much money they will need. The goal of retirement savings is trying to figure out how much of a nest egg you need to build up so that when you start living off your accumulated wealth, you have enough that you will outlive your money.

In order to figure out how much you need to retire, many banks, especially around RRSP season, will try to convince you to save as much as possible. They use scare tactics meant to convince you that you will never retire unless you save as much as possible. However, you don’t have to listen to the banks when trying to figure out how much money you need to retire. One simple way to decide for yourself what you’ll truly need to retire is the 4% rule.

What 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. If you are especially careful, your money can last even longer. It’s important to note that your portfolio composition does matter. A portfolio of at least 50% bonds at retirement will reduce volatility and increase the odds of this general calculation being reliable .

How Much Do You Need To Retire? The 4% Rule, on $100 billsAnother thing to keep in mind is that you can expect some money from the Canada Pension Plan (CPP) and Old Age Security (OAS). While many things can affect the amount you receive each month, 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.

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 it by 4%. The result, using the 4% rule, is that you would need $625,000 at retirement.

Since the 4% rule also takes into account 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.

The Realities of the 4% Rule

Like any money rule, there are limitations to the 4% rule. While the 4% rule is a simple way to calculate for retirement, it may not work out that way in real life. If 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 withdrawals in a way that allows you to outlive your money.

With market volatility, relying entirely on the 4% rule can be risky, especially if you have a large portion of your portfolio in stocks. 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. You should also consider building in a buffer. Use the 4% rule as a way to provide a general idea of how much you need to save up, but don’t assume that it is infallible.

Written by Tom Drake

Tom Drake is the owner and head writer of Canadian Finance Blog. While you’re here, consider signing up for the RSS feed or email subscription. Both deliver the latest articles directly to you! You can also follow me on Twitter for all the latest posts or to send me any comments or questions!

14 Responses to How Much Do You Need To Retire? The 4% Rule

  1. 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.

  2. 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.

  3. 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.

  4. 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.

    • Hey Uncle E, couples living on that little money (especially when split between the two of them) won’t be paying any tax. If even if only one person, they will still only pay a small percentage; nothing even close to 30% – more like single digits.

  5. One could buy $625k of rental units or a multi-tenant building which should generate roughly 47K/year if done correctly or better if you buy in strong fundamental areas. You put down 20 to 50% conservatively depending on product. Lending institution finances’s the rest.

    Market go up + inflation, rents go up and property go up (increase equity), and sell the dog units. Market go down, rents come down slightly, but more tenants available to rent from you and buy more property. Market go sideways, not much action other than mortgage paydown and buy more property. Enjoy tax advantages.

    Serve your tenants well, they reward you with retirement. Pay the tax man, the bank man, and your wife first before yourself in that order. You will “live long and prosper”.

    When you die, tax man collects payday, and bank reclaim loans. Wife takes the rest and then your progeny. Everybody wins when you’re alive and when you’re dead.

    Not sure what happens if your wife leaves you while you’re still alive, but I follow the rules above so I don’t have to find out.

    Tested and proven methodology for tens of thousand years since the end of nomadism.

    Anyway, that’s my take on retirement. Cheers.

  6. I think all of the up and down with rental units, especially those of that size, are enough to make many investors nauseous. I think we’re tallking typical everyday investors here, not millionaires. For those who want to invest in real estate to pad their retirement savings, investing in private mortgages is a far easier – and less nauseating – way to do it.

  7. According to StatsCan, the average retiree (65+) has a stash of ~$325,000.

    Your calculation of $625,000 to fuel a $50,000/yr retirement is unrealistic.
    Mathematical reality states 1% of Canadians have that much in investable assets.

    The ‘4% Rule’ is dead and needs to stay so.

  8. Corporate class low cost mutual fund with fees that ae not embedded. Super low cost. Fee is tax deductible in non registered structure. Tclass the monthly income. Not taxable income. Distribution doesn’t change throughout the year. Set it and forget it for some people. Great fit for some. Others not so much. Definitely something for people that don’t like volatility of income but want to take a market based approach. Not for everyone though. Just another tool.

  9. Great post Tom. As a financial planner the number one question that I get from clients is “Will my money last in retirement?” The truth is that saving for retirement is a big part of a stable retirement, but so is how you spend your money during retirement. I hope to see you at the Canadian Personal Finance Conference in September.

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