How much do you need to retire? The 4% rule, explained

Multiply the yearly spending you expect in retirement by 25. That is the 4% rule: the target is yearly spending divided by 4%, which is the same as multiplying by 25. If you expect to spend $40,000 a year, the rule points to $1,000,000. The rule comes from historical US market data, and it is a starting point for planning, not a promise.

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The arithmetic

Target = yearly spending ÷ withdrawal rate. At a 4% withdrawal rate, dividing by 0.04 is the same as multiplying by 25. So:

$30,000 a year needs $750,000.
$40,000 a year needs $1,000,000.
$60,000 a year needs $1,500,000.

A lower withdrawal rate needs more savings. At 3.5%, $40,000 a year needs $40,000 ÷ 0.035 = $1,142,857. That is why the rate you choose matters as much as the spending itself.

Where the 4% comes from

In 1994, William Bengen published "Determining Withdrawal Rates Using Historical Data" in the Journal of Financial Planning. He tested a portfolio of US stocks and bonds against the actual history of returns, starting in different years. He asked how much a retiree could withdraw in the first year, then raise each year with inflation, without running out over 30 years. For the hardest stretch of that history, the answer was about 4%.

In 1998, Cooley, Hubbard and Walz published a study, often called the Trinity study, that tested a range of withdrawal rates on historical US data and counted how often each one lasted. For portfolios with at least half in stocks, withdrawing 4% of the starting balance in the first year and raising that amount with inflation lasted 30 years in nearly all of the periods they studied, but not in every one.

What the rule does and does not say

The rule summarises one country's history. It is not a law of markets. Keep these limits in mind:

Time. The studies looked at about 30 years. If you need 40 or 50 years of retirement, a lower rate is the more cautious choice.
Markets. The studies used historical US returns for a mix of stocks and bonds. Other countries and other mixes have had different histories, and future returns are not known.
Before tax and fees. Taxes on withdrawals and investment fees reduce what you keep. The figures leave them out.
Spending. The rule assumes that withdrawals rise with inflation every year. Some people spend more early and less later, and that changes the answer.
Other income. A pension or state benefit covers part of your spending. Subtract that guaranteed income first, then apply the 25 times rule to the gap that is left.

This is education, not financial advice. A planner who knows your full situation can give you a better answer than a rule of thumb.

Think in today's money

Money in the future buys less because prices rise. To compare fairly, take inflation out of the return. The real return is:

real return = (1 + return) ÷ (1 + inflation) − 1

With a 5% return and 2% inflation, the real return is 1.05 ÷ 1.02 − 1 = 0.0294, or about 2.94%. Subtracting (5 − 2 = 3%) is close but a little high, and the gap grows as the numbers grow.

Using today's money keeps the target and the growth in the same unit. If you grow savings at the real return and compare the result with a target in today's prices, the two agree. If you grow savings at the nominal return and compare with today's prices, the answer looks better than it is.

A worked example

Start with $100,000 saved and add $1,000 a month. Assume a 5% return and 2% inflation, which gives a real return of 2.94% a year. The target is $1,000,000, which covers $40,000 a year at 4%.

Each month the balance grows by the monthly equivalent of the real return, about 0.24%, and then $1,000 is added. Run month by month, the balance reaches $1,000,000 after 420 months, which is 35 years.

Change one thing at a time:

Add $500 more a month, to $1,500. The target is reached in 28 years.
Plan $30,000 a year instead of $40,000. The target falls to $750,000, which the same $1,000 a month reaches in about 28 years.

What moves the answer most

Spending. The target is 25 times yearly spending, so each $1,000 less a year cuts the target by $25,000. This is the largest lever, and the one you control most directly.
Monthly saving. Money saved early has the most years to grow, so a higher monthly amount shortens the time a lot.
Return and inflation. They set the real return, and small differences compound over decades.

The budget calculator helps you estimate yearly spending. The compound interest calculator shows how growth works before inflation is taken out, which is useful for comparing with the real figure.

Steps

Estimate yearly spending in today's money with the budget calculator.
Subtract any guaranteed income you expect, such as a pension.
Multiply the rest by 25. That is the target.
Project your savings with the retirement calculator, which works in today's money and shows the age the target is reached and a balance chart.
Test a lower rate, a longer retirement and a lower spending figure, and see how much each change moves the date.