The 4% rule

On February 16, 2025 By newsroom Topic: India Money Advice

The 4% rule, popularized in Western markets, is a guideline for determining how much one can withdraw annually from their retirement savings to ensure the money lasts for 30 years. However, translating this rule to the Indian context requires significant adjustments due to India's higher inflation, differing life expectancies, tax structures, and market conditions. Here's an analysis:

Key Factors to Consider in India

Higher Inflation Rates:
- Historical inflation in India has ranged between 6-8% on average, compared to ~2-3% in mature economies.
- Real inflation, especially for urban and upper-middle-class retirees, may exceed this, considering lifestyle and healthcare inflation.

Market Returns:
- Indian equity markets have historically delivered ~12-15% pre-tax returns, while debt products offer ~6-7%. After adjusting for inflation and taxes, real returns may fall to 4-5%.

Life Expectancy:
- The average life expectancy in India (~70 years) is lower than in Western countries (~78-82 years). However, affluent individuals often live longer, requiring retirement planning for 20-30 years or more.

Taxation and Erosion of Returns:
- Taxes on long-term capital gains (LTCG) in equity and equity mutual funds (10% above1 lakh gains) can significantly impact portfolio sustainability.
- Debt products (EPF, PPF) are becoming less attractive as their yields decline, and future taxation policies might further erode returns.

Adapting the 4% Rule to India

1. Use a Lower Withdrawal Rate (2.5-3%)

Given India’s high inflation and variable returns, a 2.5-3% withdrawal rate (SWR) is more conservative and sustainable.
This adjustment accounts for higher inflation and potential market downturns, ensuring the portfolio lasts longer.

2. Build a Larger Corpus

To sustain withdrawals at a lower rate, you'll need to aim for a higher corpus:
- For a6 lakh annual expense with a 3% SWR:
- Required corpus =6 lakh ÷ 0.03 =2 crore.
- This is significantly higher than what the 4% rule suggests (?1.5 crore for the same expenses).

3. Diversify Asset Allocation

Equity Allocation: 60-75% for higher growth potential.
Debt Allocation: 25-40% for stability and cash flow. Use instruments like PPF, EPF, debt mutual funds, and bonds.
Adjust allocations annually based on market conditions and inflation.

4. Consider Flexible Withdrawals

Avoid rigid withdrawals. Instead, reduce withdrawals during poor market performance (e.g., limit to dividends) and withdraw more during bullish phases.

5. Account for Healthcare Inflation

Healthcare inflation in India (~12-15%) is much higher than general inflation.
Allocate a separate healthcare corpus or opt for adequate health insurance.

Practical Scenarios

Conservative Assumptions:
- Inflation: 6% - Equity Returns: 10% pre-tax (9% post-tax)
- Safe Withdrawal Rate (SWR): 2.5-3%

For a ?50,000 monthly expense (?6 lakh annually):
- Corpus Required =6 lakh ÷ 0.03 = ?2 crore.

Aggressive Assumptions:
- Inflation: 5%
- Equity Returns: 12% pre-tax (10.8% post-tax)
- SWR: 3.5%

For the same expenses:
- Corpus Required =6 lakh ÷ 0.035 = ?1.71 crore.

Challenges to Watch For

Market Volatility: A few bad years early in retirement can severely impact your corpus (sequence of returns risk).

Policy Changes: Increased taxes on LTCG, reduced yields on debt instruments, or changes to EPF/PPF rules could hurt returns.

Unexpected Expenses: Rising medical costs or unforeseen liabilities can derail plans.

Recommendations

Aim for a Higher Corpus: Over-save and plan for a 20-30% buffer to cover contingencies.

Keep Monitoring and Rebalancing: Regularly review expenses, returns, and inflation trends.

Use Hybrid Products: Consider SWPs in balanced funds, dividend-yielding stocks, and annuities for a mix of growth and stability.

Bottom Line

The 4% rule doesn’t translate directly to India due to structural differences in inflation and returns. Adopting a 2.5-3% withdrawal rate with a diversified portfolio and periodic adjustments offers a safer alternative for Indian retirees. Start early, invest aggressively in growth-oriented assets, and maintain a disciplined withdrawal strategy for financial independence.