The 4% rule is a popular method in retirement planning. It provides a simple and conservative guideline for estimating the amount you can safely withdraw from your retirement funds each year, with the goal of ensuring your financial security throughout your retirement years. Following the 4% withdrawal rule can greatly reduce the risk of running out of savings too soon, thereby increasing the likelihood of financial security throughout retirement.
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How does the 4% rule work?
Here’s a step-by-step breakdown of how the 4% rule works, as per the ICICI Direct website.
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Calculate Your Retirement Nest Egg
Determine how much money you will need annually in retirement to maintain your lifestyle. It will require some effort, but with little research, you can know your number. The number will vary greatly depending on parameters like your current expenses, expected inflation, and desired retirement age.
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Once you have an estimate of your annual retirement expenses, multiply this amount by 25. The logic behind this step is that 4% of your savings can be withdrawn each year, and 1 divided by 0.04 (1/0.04 = 25) gives you the multiple needed.
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In the first year of retirement, withdraw 4% of your total retirement savings. For example, your retirement corpus is Rs 1 crore. Now initial withdrawal would be Rs 4,00,000 (4% of Rs 1 crore).
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Each subsequent year, adjust your withdrawal for inflation. Historical data shows that an annual inflation rate of around 6% is a reasonable estimate in India. So, if you withdrew Rs 4,00,000 in year one and inflation was 6%, you would withdraw Rs 4,24,000 in year two.
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Periodically reassess your financial situation and adjust your withdrawals if necessary. If your portfolio has experienced significant gains or losses, you may need to adapt your withdrawals to maintain a sustainable income stream.
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