Explaining the basic (but life-changing!) “4% Rule” – which lays out a path to retiring safely at any age.
The “safe withdrawal rate,” also commonly referred to as the 4% rule is simply this: You can withdraw 4% of your invested assets…forever! It’s not a particularly new or complicated concept, but it can radically change the way you save, spend, and (hopefully) retire.
The way it works is this: we can assume average rates of return in the stock market will be above 4% (6% seems safe when factoring inflation). What that means is that you can withdraw 4% of your portfolio every year without ever touching the initial investment amount (the “principal”). I’m gonna take this moment to plug my post on index funds so you’re not inclined towards any get-rich-quick ideas.
For a simplified example, if you have $1,000,000 invested, you can never save another penny and withdraw $40k/year forever, no matter how young you are.
$1,000,000 * .04 = $40,000/yr.
Even accounting for inflation (in the form of increasing your withdrawals by 2% every year), you’ll see that after 30 years there’s still plenty of money left to keep on retirin’
How Spending (Not Saving) is the Key to Early Retirement at 4%
Another way to look at the 4% rule is that you need 25x your annual spending to retire this way. Read that again; it doesn’t matter what you make, it matters what you spend. There are plenty of early retirees that have gotten out of the race with well under $1M. I used that number because it’s a common milestone people throw around, but the 4% rule works no matter what you save, it’s the spending that’s key. Here are a few scenarios:
| annual spending | required savings | notes |
| $25,586 | $639,200 | 2x “poverty threshold” for an individual |
| $32,494 | $812,350 | 2x “poverty threshold” for a household |
| $36,000 | $900,000 | $3,000/mo |
| $43,000 | $1,075,000 | median US income for an individual, 2020 |
| $68,400 | $1,710,000 | median US income for a household, 2020 |
| $80,000 | $2,000,000 | a whole lot of money |
Now, everyone has their own idea of what retirement should be. There are perfectly happy, successful people that retired at 30 and live on $27k/yr. For others, including plenty of six-figure earners living paycheck to paycheck, it’s basically impossible for their savings to ever outpace their spending (which may even be true for us! but we haven’t figured that out yet).
Your Pre-Retirement Income is NOT Your Post-Retirement Spending
One thing to remember when looking at these figures is this: Under the 4% rule in retirement, you never need to save another dollar. So if you’re a good saver earning $68,400/yr and thinking you’ll never hit that $1.7M number, don’t fret; a good portion of your income is currently going to savings/401k, which (along with other costs of working like commuting, office clothes, dry cleaning) will no longer be necessary in retirement. Ideally, you will be aggressively paying down your debt while you work; so if you can pay off your house before retirement, that’s another major cost you can strike. That’s why all the retirement advice about “expect to spend 75% of your before-retirement income” or whatever is bullshit.
It’s [almost] never about what you earn, it’s only about what you spend.
– me, just now
Our Numbers
The painful truth is we don’t currently know what our “magic number” will be, because we’ve been playing ostrich about our spending for too long. Lifestyle creep has been a huge factor in this, but the reality is our incomes have made us feel comfortable spending without too much thought. Obviously it’s impossible to know when you’re free to retire with the 4% rule if you don’t have a decent idea of what your spending looks like, so that’s the next major hurdle for us to clear.
In the meantime, we’ll keep focusing on emptying the jar and try to be more conscious about our choices & habits. In a future post, we’ll dive into our Mint account and try to figure out how we’ve been doing on auto-pilot.
What’s your magic number? Is your spending on track already?
Does this work without a 401k? And starting savings of 3,000?!?
Absolutely! It’s actually easier without a 401k in some ways because if you want to retire early and your money is in tax-advantaged accounts like a 401k/IRA you have to go through a complicated thing called a SEPP (substantially equal payment plan) to get at that money without penalties.
$3,000 is exactly the amount you need to begin investing in VTSAX (vanguard total index fund ‘admiral shares’)!! So if you haven’t maxed out your contributions, I’d start with an IRA (or SEP-IRA if you’re self-employed), 401k if your plan offers it, or if you don’t feel like all that just open a taxable brokerage acct, drop that $3k into something safe and set up an automatic contribution of just a little bit to get started!