Retirement is one of the most challenging financial goals you’ll ever have to work toward. It requires you to anticipate what your daily spending habits will be years, even decades, into the future. It’s virtually impossible to predict your future expenses—so it can be difficult to imagine what you’ll be paying decades from now.
Fortunately, there are models that exist to help you estimate what you may need for retirement, including the “Rule of 300” and the “4% Rule”. While these models are not meant to accurately predict the future, they can help you think constructively about your current planning efforts.
The Rule of 300
For this calculation, you take your current monthly expenses and multiply that amount by 300. The resulting amount is an estimate of how much you may need to have saved to keep living the lifestyle you currently lead when you’re retired.
While the Rule of 300 allows you to estimate how much you may need to save for retirement, it doesn’t consider inflation. However, the 4% rule seeks to do this.
The 4% Rule
Another model that you can use is "the 4% Rule." For this method of calculation, you take the balance of your current investment portfolio, multiply it by 4% and then divide it by 12. This helps you estimate how much you may be able to spend on monthly expenses during your first year of retirement. In subsequent years, the amount should be adjusted to account for inflation.
Based on a study from 1994 that analyzed data from 1926 to 1976, the 4% Rule seeks to determine the maximum amount someone could take from their investments while adjusting for inflation. William P. Bengen, the creator of the concept, argued that individuals could draw 4% of assets in the first year, adjust that amount for inflation each year, and not run out of money over a 30-year period. The 4% Rule assumes that portfolios will grow by at least 4% yearly to accommodate for inflation.
Some people are cynical about whether the 4% Rule is a good strategy for retirement planning. In 2020, Bengen said the 4% rule has been historically oversimplified, claiming his research illustrated a “worst-case scenario.” He now thinks new retirees should consider withdrawal rates of no more than 5%. Ultimately, Bengen warns that the 4% Rule—like many financial maxims—should not be treated as absolute.
Downsides of the Rule of 300 and 4% Rule
There are downsides to every forecasting model. While the Rule of 300 and the 4% Rule may be straightforward, neither considers every possible scenario.
There are fluctuations in the market. There are situations when the market collapses, like in 2008 and 2009 during the housing crisis. The economy may also take unexpected downturns such as during the COVID-19 pandemic. These unexpected events could affect your investment portfolio, impacting the funds you anticipated having for retirement.
Another downside of these models is that they cannot account for changes in your lifestyle over the years. As The Fifth Person notes, even from the age of 65 to 90, you cannot assume you’ll have exactly the same lifestyle with the same expenditures month after month. Your interests and tastes are likely change over time, and you’ll need to adjust your finances to accommodate those lifestyle changes.
Like with health insurance, there is no way to anticipate every possible health care cost you could face when you’re older. Doctors and treatments can become expensive and could quickly deplete retirement income.
While the amount that you may need for retirement can seem daunting, we think it’s important to remember that compound interest can help make your goals more attainable. We believe the key is to get started as early as possible to help give compound interest time to work.
Additionally, the amount you need to achieve financial freedom in retirement may not be solely based on your income; it also depends on your expenses. Reducing and learning to live with fewer monthly expenses may help lower the amount of income you need for retirement—in turn, it could help you reach the amount you need for retirement more quickly.
Rule of 300 and 4% Rule: Bottom Line
The Rule of 300 is a way to get a general idea of how much money you may need for retirement. Neither the 4% Rule nor the Rule of 300 should be the sole determination of how much you will need for retirement. But they may help you gain perspective on how close you currently are. Human Interest offers affordable retirement plans that may help small businesses and their employees save for the future. Learn more about starting a plan today.
Article ByThe Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.