What Is 4% Rule? Meaning & Example

The 4% rule is a rule of thumb for how much a retiree can withdraw from an investment portfolio each year without running out of money. It says: withdraw 4% of the corpus in the first year, then increase that rupee amount by inflation every year afterwards, regardless of what markets do.

The convenient corollary is the 25 times rule: if 4% is your withdrawal rate, then the corpus you need is 25 times your first year of expenses.

It originated in American research on US market history over rolling 30-year retirement periods, most famously the Trinity Study. That origin is the whole reason it needs adjusting before being applied in India.

The arithmetic, with Indian numbers

Suppose your annual expenses at retirement are Rs 9,00,000, which is Rs 75,000 a month.

At 4%, the corpus needed is 25 times that, which is Rs 2.25 crore.

At 3.5%, the multiple becomes about 28.6 times, so Rs 2.57 crore.

At 3%, it is 33.3 times, so Rs 3 crore.

Half a percentage point on the withdrawal rate changed the target by more than Rs 30 lakh. This is why the number you assume matters far more than which funds you pick.

Work out your own figure with the retirement calculator, and remember to inflate today's expenses to what they will cost at your retirement date before applying any multiple.

Why 4% is usually considered too high for India

Inflation has historically run higher than in the US. The rule was built around long-run US inflation. Indian retirees have generally faced higher general inflation, and medical inflation in particular has typically outpaced the headline rate. A withdrawal that rises faster in rupee terms drains a corpus faster.

The horizon is often longer. The original research tested 30-year retirements. Someone retiring early, which is the whole premise of the FIRE movement in India, may need the money to last 40 or 50 years. The rule was never tested for that.

Sequence of returns risk is unforgiving. Two retirees with identical average returns can end very differently depending on when the bad years arrive. A severe fall in the first three years, while withdrawals continue, permanently reduces the capital base that the later recovery works on.

Costs and tax reduce the real rate. Every fund charges an expense ratio, and withdrawals attract capital gains tax. A 4% gross withdrawal is a smaller net amount in your hand.

For these reasons, Indian planners commonly discuss 3% to 3.5% as a more defensible starting rate, which translates to a corpus of roughly 28 to 33 times annual expenses.

What the rule leaves out entirely

It assumes a fixed real withdrawal forever, which no real retiree actually does. In practice people spend more in the early active years, less in the middle, and more again on healthcare later.

It ignores other income. A pension, NPS annuity, rental income or part-time earnings all reduce what the portfolio has to provide, and therefore reduce the corpus needed.

It assumes you hold your nerve through every crash without cutting spending, which is both unrealistic and unnecessary. A retiree who simply skips the inflation increase after a bad year materially improves the odds of the money lasting, at very little cost to their life.

And it says nothing about health cover. In India, adequate health insurance is arguably a bigger determinant of whether a retirement corpus survives than the withdrawal rate is, because a single uninsured hospitalisation can remove years of planned withdrawals at once.

How to use it sensibly

Treat it as a sanity check, not a plan. Use 25 times expenses to know roughly what order of magnitude you are aiming at, then plan against a lower withdrawal rate, keep two to three years of expenses in debt or cash so you never have to sell equity into a crash, and stay flexible about the inflation increase in bad years.

This is general educational information about a widely discussed rule of thumb, not personalised financial advice. For a plan matched to your own situation, speak to a SEBI-registered investment adviser.