Whether you're decades away or around the corner from retirement, planning for your Golden Years can be daunting, especially in today's economy.
The 4% rule can help. It came from the brain of Certified Financial Planner and author William Bengen in the '90s. The general idea is that you should be able to fund your retirement by withdrawing 4% annually from your nest egg and investments.
How to calculate what you'll need in retirement: Think about basics like housing costs, groceries, transportation, and potential long-term healthcare. Maybe you'd like to travel or have a second home in sunny Florida. Account for those as well.
- Once you've tallied those costs, you'll have an idea of how much you'll be spending each year of your retirement, and it's suggested that you cushion that amount a bit to account for inflation—so if your total is $40,000, tack on another $5,000.
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Factor in pension payments like Old Age Security (OAS) and Canadian Pension Plan (CPP) payments. These amounts vary depending on your marital status, how much you paid into them and how much you earned.
- For the sake of easy math, let's say you'll get $25,000 annually from pensions. That means you only need to fund the other $20,000 yourself.
- Divide $20,000 by 0.04%. With these numbers, you'll need $500,000 to fund your 30-year retirement.
Yes, but: There's a lot of debate about how relevant the rule is today.
- Some financial experts say the rule is outdated, calling it "a leading example of the divergence between finance theory and practice" since people tend to live longer (and need more money) and market conditions are more volatile than 30 years ago.
Bottom line: There's no one size fits all rule to retirement planning, but the 4% rule is a starting point if you've never sat down and thought about how you'll get through your non-working years.