Since 1994, when William P. Bengen published his research showing that a retiree could take out approximately 4% of his retirement portfolio, adjust it annually for inflation, and be reasonably sure to outlive his money, 4% has become somewhat of an industry standard for the safe retirement withdrawal rate.
Safe Withdrawal Rates - More Than a Rule of Thumb?
But, like any other rule of thumb, certain problems are presented when the guidance is looked at closely. As Michael Kitces told the advisor community in “Resolving the Paradox – Is the Safe Withdrawal Rate Sometimes Too Safe?” (May 2008), a scenario where two couples with identical portfolios retire a year apart can lead to surprising and somewhat illogical results. If the market were to increase or decrease substantially during the year when one couple retires but the other has not, each couple will be advised of fairly different safe withdrawal amounts over the rest of their lives. This occurs despite having the same portfolio. Only the timing of their retirement date causes the dramatic difference in the suggested standard of living.
What’s the Proper Safe Withdrawal Amount?
No sure risk-free solution to a safe withdrawal rate exists. (Every suggestion has either the risk that you spend too much too quickly and run out or that you spend too little and, late in life, become disappointed you didn’t spend more earlier on during retirement). My suggestion is to start at approximately 4%, but to be mindful of some key factors that may guide you to spend more or less in any given year:
- Your health may decline as you get older. Consider spending more in the beginning of retirement on items like travel and vacation.
- The market may take a severe downturn shortly after you retire. Consider ratcheting back spending in the early years to give your investments a chance to come back rather than realizing your loss by selling at a relative low point.
- You may outlive your live expectancy. Consider combating this possibility by the purchase of an immediate annuity or a longevity annuity.
Not a Sure Thing
You can see why it’s virtually impossible to give precise guidance to how much you can afford to spend in a given year during retirement. Yet, as people crave simplification from the increasingly complicated concept of retirement, rules of thumb can be useful. Personally, I will strive to start at 4% one day, knowing there are a bunch of variables, many of which I cannot control, that may change my ultimate spending ratio.
Keep Tabs on Yourself
The close monitoring of your portfolio and spending, possibly with a competent financial advisor at your side, can give you the confidence to spend comfortably on the items you truly desire with the timing that makes sense given your overall goals for retirement.