What’s your number? The 4% retirement rule

I was at a professional development session in Calgary this week when one of our financial planners was asked a familiar question: How much money do I need to retire?

Her answer started with the old 4% rule.

I appreciated the simplicity. Retirement planning can quickly become complicated with taxes, inflation, pensions, CPP and OAS, investment returns, longevity and estate goals all entering the equation. Sometimes it's useful to step back and start with a simple goalpost.

The 4% rule basically says that a retiree can withdraw approximately 4% of their investment portfolio in the first year of retirement, then increase that dollar amount with inflation in subsequent years.

Using that math, a $1 million portfolio would initially provide about $40,000 per year, or $3,333 per month, before tax. Add CPP, OAS or a workplace pension and you begin to get a rough idea of what retirement income might look like.

You can also work the calculation backwards. If you want your investments to provide $60,000 per year, dividing that by 4% gives you a rough retirement target of $1.5 million.

Of course, calling 4% a "rule" is probably giving it too much credit.

Capital Group recently revisited retirement withdrawal strategies and found that a fixed withdrawal rate of roughly 4% to 4.5% could provide a reasonable starting point, depending on an investor's circumstances. In its modelling, starting at 4% provided an 81% chance of reaching age 95 with at least 20% of the original portfolio remaining.

But small changes mattered. Increasing the starting withdrawal to 4.5% reduced those odds to 65%.

There is also another way to approach the problem. Instead of withdrawing a fixed dollar amount each year, retirees can take a percentage of whatever their portfolio is worth. Capital Group tested withdrawals of 5% to 5.5% using this approach. The advantage is that it's much harder to completely exhaust the portfolio. The disadvantage is that income can fall considerably following a difficult year in the markets.

And that highlights why retirement planning can't really be reduced to a single number.

Someone retiring at 55 has a very different challenge from someone retiring at 70. Spending isn't always constant either. Taxes matter, unexpected expenses happen, markets don't move in straight lines and some people want to leave a substantial estate while others intend to spend most of their savings.

Still, I think there's value in keeping the 4% guideline in mind.

Not because everyone should blindly follow it, but because it provides a surprisingly useful answer to one of retirement planning's biggest questions: Am I even in the ballpark?

Once you know that, the real planning can begin.

Fraser Betkowski

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson Wealth Limited or its affiliates. Richardson Wealth Limited is a subsidiary of iA Financial Corporation Inc. and is not affiliated with James Richardson & Sons, Limited. Richardson Wealth is a trade-mark of James Richardson & Sons, Limited and Richardson Wealth Limited is a licensed user of the mark. Richardson Wealth Limited, Member Canadian Investor Protection Fund.