How Much Money Do You Need To Never Work Again

You are under appreciated at work. As a kid, you never thought that life was supposed to be like this. How much cash would it take to be free of financial concerns and never have to work again? The common answer to this question is 25 times what you spend every year (the 4% rule). However, this 4% figure is often misunderstood. Where do the guidelines come from for determining what a good number is? In addition, there are downright philosophical answers to this question of how much do I need. How much money do I need to feel empowered versus how much of empowerment is simply a mindset? How much money is enough for you personally? What if, insert your tragedy of choice, happens?

We will explore all of these mysteries and more in this one article! Heck we might even find out where Jimmy Hoffa is buried and finally locate Amelia Earhart's plane. Let's dive in!

Being Rich Versus Enough To Never Work Again

I've written in the past about how much money you need to be rich. Spoiler alert, the research suggests that you will never emotionally feel like you have enough. Ultimately, it becomes a choice and a state of mind to claim financial independence rather than run on the endless hamster wheel of trying to be "rich." I will explain how much savings it takes to be financially independent. However, even still there is always the chance of a looming tragedy or a fear that you have grossly miscalculated your needs.

There will always be "what ifs." I've written in the past about how fearing the worst affects one's world view which in turn affects one's actions, which become one's life. It is my belief that a certain level of rational optimism must accompany a realistic financial number in order to truly Live a Life Outside The Maze. However, beyond these mentalities, there is still some minimum hard cash number that one needs to be able to pay the bills. I am not a *financial professional but let's dive into measuring and accounting for risk and a safe withdrawal rate looking at the research of those who are. This is where the often talked about 4% rule comes in.

What Is The 4% Rule?

The 4% rule indicates from historical data that if you accumulate enough wealth that your annual expenses are 4% or less of your total portfolio, you can retire. In other words, if you save up 25 times your total annual spend and your annual spend never changes, it will likely last through a traditional retirement (30 years). If your annual expenses will always average $61K for example (this is the average annual household spend in the US), then you need to save and invest 25 times $61K = $1.525M to retire at the traditional age (more once you include taxes and fees paid on investments and capital gains which we will get to shortly).

Where Does The 4% Rule Come From?

The 4% rule was proposed by a CFP named William Bengan in the 90's, and has been analyzed subsequently by three professors at Trinity College in the now famous "Trinity Study" which was updated in 2011. It has also been challenged with historical data by Michael Kitces.

How Often Does The 4% Rule Fail?

Interestingly, the 4% rule is based off of a stock and bond portfolio mix and different mixes were analyzed over time periods. If the cash did not run out after said time period, the portfolio was considered a "success." In the updated Trinity Study, a 50/50 stock and bond portfolio was a "success" over every 30 year span 96% of the time. Hence, it is often stated that the 4% rule has a 96% success rate. However, this is just one possible portfolio allocation covered in the study. This table from the updated Trinity study gives more complete insight and shows different allocation percentages that were also studied:

Table Source: Cooley, Philip L.; Hubbard, Carl M.; Walz, Daniel T. (2011). "Portfolio Success Rates: Where to Draw the Line".

Of particular note above is that a 75/25 stock/bond allocation actually had a better "success rate" over 30 years than the 50/50 or 100/0 portfolios. This seems to follow the standard portfolio advice for long term investing that often suggests somewhere around a 60-80% allocation in stocks.

Does the 4% Rule Account for Inflation?

Yes, it does. Inflation is a big deal. If inflation averages 3% per year, the actual purchasing power of that cash gets cut in half after 23 years. The Trinity Study historical "success" results and charts shown herein adjust for inflation (in the form of factoring in consumer price index data over time). Hence, the way to live on the 4% rule is to spend 4% of your portfolio in year 1 but then raise your spending to account for inflation each year.

For example if living off of $40K per year in year 1 but inflation is then 2% I would withdraw 1.02 x $40K = $40.8K in year 2. If inflation is 3% next year, I would then live off of 1.03 x $40.8 = $42K in year 3. This is similar to cost of living increases in a paycheck. Hence, the 4% rule does factor in inflation based on the historical average. Of course it should be mentioned that there is no guarantee that future inflation will match past inflation averages.

Does the 4% Rule Account for Taxes and Fees?

No it does not. This is a huge and often overlooked point. Taxes and fees are unique to the individual's situation and are not included (I will come back to this in more detail in part 2). In short, if there are fees on your investment vehicle and your investment gains are taxable these both reduce your true spending amount making it lower than 4%. You can alternatively account for this reduction by including your estimated taxes and fees in your spending budget and then multiplying by 25 to get your "never have to work again number" under the 4% rule.

Taxes may include capital gains or income taxes depending on what type of account your investments are in (401k, Roth, traditional account). The Trinity Study also assumes a straight investment in the S&P 500 with no fees. In reality, investing in the S&P 500 is usually done through a mutual fund which could have a management fee of 0.5% or more. This means living off of the 4% rule becomes living off of 3.5% of your portfolio after fees. Vanguard's VTI has a super low management fee of 0.04% by comparison. This is one of the reasons that everyone loves Vanguard (except greedy investment advisors who want higher fees).

But I want To Live Off That Cash For Longer Than 30 years!

Both Bengan's analysis and the Trinity Study were geared toward traditional retirees with time horizons around 30 years. Drawing down the account to $1 over 30 years was still considered a "success" in these studies. However, what if you want to quit the grind early? What if you want your cash to last 60 years or longer? This is perhaps the least understood thing about the 4% rule and the most important for an early retiree.

The Most Misunderstood Thing About the 4% Rule

In the updated Trinity Study, the median amount left in your 50/50 stock and bond account after 30 years considering all 30 year periods analyzed is 291% of what you started with. You read that right, the median return is that you will have around 3 times what you retired with after 30 years of living on the 4% rule. Around 50% of the time the portfolio ends that 30 year period with more money than at the beginning. The following chart shows the data for all portfolios analyzed in the updated Trinity Study:

This all makes the 4% rule sound pretty attractive, so what is the problem? The problem is that many assume that because 96% of the time, things work out over 30 years, this can just be carried forward to a 60 year timeframe for the very early retiree and have a similar success rate. After all, wouldn't a longer time horizon just smooth out the variance?

What About The Other Half of The Time?

The problem is not the average return but the roughly 50% of the time where principal has actually diminished after that first 30 years instead of grown. If an early retiree has a 60 year time horizon, the next 30 years start with less principal 50% of the time. It is essentially like re-retiring for a 30 year time span under the Trinity study but with substantially less money. This can meaningfully impact success rates. In fact, an analysis by one PhD economist shows that the same 50/50 4% withdrawal portfolio that the updated Trinity Study reported a 96% success rate for over 30 years, only has a 65% success rate when extended to 60 years! This makes a compelling case that the 4% rule could perhaps be lowered to something like 3.5% or even 3.25% for an early retiree if one requires a 96% success rate similar to the Trinity Study over 60 years and will blindly spend 4% every year regardless of what happens in the markets.

Sequence of Return Risk

An analysis of historical data by renowned financial planner Michael Kitces also found that someone considering a 40 year or longer retirement as opposed to a 30 year one, may want to consider something more like a 3.5% withdrawal rate as opposed to 4%. However, it turns out that the biggest risk to someone with a 40-60 year retirement timeline is the possibility of a catastrophic market crash very early in retirement.

Mr Kitces further calculates that the first decade of retirement withdrawals is critically important. If a catastrophe happened in that first decade, this is when it becomes very impactful to the success rate of a 4% withdrawal portfolio plan. In other words, if a crash comes early, you are taking out principal at low stock market prices and also missing out on any of the returns on that principal as the market recovers. This is what sequence of returns risk is.

The silver lining of this is two fold:

#1 it may be easier to analyze and predict the likelihood of a catastrophic event in the first decade based on current market conditions than it is for 60 years.
#2 if a catastrophe happens early, this offers the retiree more time to adjust and even return to making a bit of income if necessary.

Predicting A Safe Withdrawal Rate

With sequence of returns risk, I just explained how the first decade is super important in retirement. This is somewhat advanced but what if you could predict to an extent what was going to happen in that first decade? For those considering early retirement in the near term, something called the CAPE ratio may be worth looking at (cyclically adjusted price to earnings ratio). It was invented by a nobel prize winning economist. This indicator has shown historically to be a pretty good predictor of returns on equity when investing in the stock market over a 10-20 year time frame.

In other words, a low CAPE means more value for your money. When historical data is analyzed, it turns out that safe withdrawal rates have a higher percentage of failing when CAPE ratios are high. In short, some analysis that I will link to right here and here indicates that if the CAPE is very high as one approaches retirement, it may be prudent to lower one's safe withdrawal rate from 4 to 3.5% for example or even consider a different portfolio percentage allocation until the CAPE changes.

As I write this article in late 2020, the CAPE sits above 30 and the first resource linked to above shows a possible 50% failure rate based on historical data for retirees who start their first decade of retirement following the 4% rule under these market conditions. Conversely, when retirees started retirement when the CAPE was less than 20, there was never a failure of the portfolio over any 30 year period studied.

Criticisms of The 4% Rule

I have already covered some of the major criticisms of the 4% rule:

It is based on a 30 year time horizon and hence carries greater risk for a 40-60 year horizon.
What if a worst case market crash happens early in your "retirement?"
The 4% rule does not include taxes on your investment income nor investment fund management fees which could reduce your effective retirement budget.
What if the future stock market behaves nothing like the past?

Based on these concerns one could lower the targeted safe withdrawal rate to 3.5% or even 3.25% to account for all these concerns. One could also accept a greater risk that the portfolio will not hold up and additional income may be needed at some point.

Is The 4% Rule Still Safe?

The answer to this has broad consensus in one sense. All of the data analysis that I have ever seen and every resource cited in this article shows that living off of something between 3 and 4.5% of a portfolio of around 75% broadly diversified stocks with the balance in bonds or something similar is a reasonably safe financial plan even for a 60 year retirement as long as the future matches historical data. The heated debate centers around exactly whether that % should be 3, 3.25, 3.5, 4, or 4.5%. In practice, living on $40K per year would require $1,142,857 under a 3.5% rule versus a cool $1M under the 4% rule. Hence we are talking about potentially needing to save around 14% more or less to put this into perspective for your planning.

The 4% Rule Is Historically and Mathematically Not Safe For Long Retirements

The common belief that a 4% rule 50/50 portfolio of stocks and bonds lasted forever 96% of the time under historical review is flawed. The risk profile of this portfolio goes up considerably for early retirees with up to a 45% failure rate over 60 years rather than 4% failure rate over 30 years! According to the updated Trinity Study, most financial planners use a minimum of a 75% historical success rate as a floor for creating a "safe" retirement plan and the 50/50 portfolio does not meet this. In my opinion, this deserves more clear acknowledgement in the financial independence community. the 4% rule also does not factor in taxes and fees which is an important and actionable clarification for anyone making their plan (this will be covered more in part 2 of this article).

However, it is important to understand that the supposed "4% rule" is not a rule at all but simply a title for the broader process of quantifying risk in a financial plan based on historical data. There is a solid rationale beyond the math that a 4% benchmark is not an irresponsible starting place.

Why a 4% Withdrawal Rate May Make Sense: Beyond The Math

This article has laid out mathematically why various portfolios with a 4% withdrawal rate are very safe for a 30 year retirement but not for a longer 40-60 year one. At the same time, the 4% rule assumes that you blindly draw down cash at the same rate regardless of whether there was a giant crash or an insane bull market run. In reality you can tighten the belt to something akin to a 3.5% rule if the market does crash early.

The 4% rule also assumes that one will have absolutely no income after "retiring." I know exactly no one who left work early and did nothing that generated any income over 60 years. It's just kind of hard not to make at least a little income when we live in a capitalist society and one continues to apply themselves. I discussed this in more detail in "Why You Need To Work Forever and Never Retire."

We discussed above that avoiding a giant hit to your portfolio in the first decade of retirement is a huge determiner of its longevity. Part of the beauty of an early retirement is that if you retired in your 30's or 40's for example and something happened in that first decade, having to raise a bit more cash in your 40's or 50's would not be a devastating blow. Conversely, the even betting odds are that you will be fine so why preemptively work longer than necessary when you don't even know how much time you have left?

Lastly, humans are naturally risk averse. This is Darwinian and why your gene pool has survived this long. But have you factored in a likely inheritance from any of your loved ones that may pass before you? Have you factored in social security in your golden years? Can you be comfortable under something close to a 4% rule with the understanding that you will tend to your portfolio and practice some creativity, thrift, and use currencies beyond money rather than just creating a 60 year "bullet proof" plan and following it like a machine? I started this article with the point that financial independence requires a state of mind just as much as it requires a realistic number. These are some of the intangibles beyond the math.

The Final Word On How Much You Need To Never Work Again

We didn't find Jimmy Hoffa or Amelia Earhart's plane. However, you probably understand the 4% rule much better now and have a great sense of what you actually need to have a realistic portfolio and risk profile. It turns out that the 4% rule is more of a guide than a law.

What if your money is in things other than just an SP500 fund and high grade corporate bonds? How does it matter if your cash is in a Roth vs a 401K vs a regular investment account? What about social security? I share some thoughts on how to handle unique situations in How Much Do You Need To Never Work Again Part 2.

If you want to understand more about the mechanics of the 4% rule and safe withdrawal rates this is a topic that has been covered extensively by some super capable people. Here are some more resources that I can personally recommend:

Solid Overviews of the 4% Rule:

JL Collins: The 4% rule, withdrawal rates and how much can I spend anyway?
Mad Fientist: Safe Withdrawal Rate for Early Retirees
Money Crashers: Safe Withdrawal Rates for Retirement – Does the 4% Rule Still Apply?

The 4% Rule May Be Fine: Reasons Beyond the Math

Mr Money Mustache: How Much Do I Need For Retirement?
1500 Days: Why the 4% Rule Won't Steal Your Spouse or Give You the Clap and Why I Think The 4% Rule Sucks (The Most Case Scenario)

The 4% Rule May Not Be Adequate: 3.5% and Spending Rules

Forbes: Triple Your FIRE Portfolio's Size By Using The 3.5% (Not 4%) Rule
Choose FI: Beyond 4%: The Argument for Flexible Spending Rules in Retirement

Deep Diving Safe Withdrawal Research Resources:

Early Retirement Now: is run by Karsten, an economics PhD who wrote a huge 39 part (and growing) series on Safe Withdrawal Rates.
Michael Kitces: a renowned financial planner has a website and newsletter with loads of unique research and useful information into safe withdrawal rates.
Wade Pfau: another PhD researcher into retirement planning who has lots of unique research and useful articles.

Do you still have unanswered questions or feel I got something wrong? Check out part 2 of this article or feel free to post a comment or question below.

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*I am not a financial professional and everything on this site and in this article should be considered for informational purposes only and should not be considered financial advice for any individual. Your financial situation is unique to you.