If you’ve done any research on planning for retirement, you’ve probably come across the 4% rule.
It originates from the US (specifically, Trinity University from Texas). This idea, like many US ideas, has spread around the world – including New Zealand.
The basic message behind the 4% rule is that you can safely withdraw 4% from your investment portfolio and sustainably support yourself through retirement.
It implies that to work out how much you need to retire, take what you want to spend each year, and multiply it by 25.
I don’t like the 4% rule.
For one thing, there’s a time and place for simple heuristics and rules of thumbs. But retirement planning is not the time or place.
The other reason is specific to New Zealand. The 4% rule doesn’t factor in New Zealand’s universal superannuation regime.
In most cases, an individual who turns 65 will receive about $21,000 per year in NZ Super. A couple will receive about $32,000.
If you’re getting close to the age of 65, it means your retirement nest egg only needs to supplement your NZ Super.
If you want $50,000 in retirement and you follow the 4% rule, you might think you need $1.25 million. But if you factor in NZ Super of $32,000, so you only need $18,000 per year, the figure drops to $450,000.
Adding one simple factor – NZ Super – substantially changes how much you think you might need to save for retirement and might influence some of the important life decisions you might end up making – such as when to retire, how much to work (and the type of work you do), how much to save, how much to spend, and how much to help out your children.
If you expect to retire well before age 65, you’ll need to adjust the figures further. And the 4% rule goes out the window.
Admittedly, there’s a fair degree of uncertainty in relation to whether younger people will receive NZ Super and what level they’ll receive. But that is the point! There is uncertainty around many things relating to retirement planning (including your health, longevity, broader family situation, other Government policies such as funding for residential care, property prices, and your investment returns).
This goes back to my first point about why I don’t like the 4% rule in the first place. It lacks nuance. It lacks any appreciation of the uncertainties that the future provides or any appreciation of your personal circumstances.
Retirement is important! It deserves better than a simple rule of thumb.
Please! Don’t be fooled by the 4% rule.