Greetings! I trust that this will find you well and enjoying life.
During your working years you’ve probably set aside funds in retirement accounts such as IRA’s 401k’s, as well as taxable accounts. Your challenge during your retirement years is to convert those savings into an ongoing income stream, that will provide adequate income throughout your retirement years.
There are several commonly recognized methods to convert retirement accounts into a monthly check that arrives in your mailbox on the first day of the month. Over the next few weeks I will cover Ones frequently used; today I want to examine spending down a diversified mutual fund portfolio of stocks, bonds and other asset classes.
Your retirement lifestyle will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio. The annual percentage that you take out of your portfolio, whether from returns or the principal itself, is known as your withdrawal rate. Figuring out an appropriate initial withdrawal rate is a key issue in retirement planning and presents many challenges.
Take out too much too soon, and you might run out of money in your later years. Take out too little, and you might not enjoy your retirement years as much as you could. Your withdrawal rate is especially important in the early years of your retirement as it will have a lasting impact on how long your savings will last.
So, what withdrawal rate should you expect from you retirement savings? One widely used rule of thumb states that your portfolio should last for your lifetime if you initially withdraw 4% of your balance (based on an asset mix of 50% stocks and 50% intermediate-term Treasury notes), and then continue drawing the same dollar amount each year, adjusted for inflation. However, this rule of thumb has been under increasing scrutiny.
Some experts contend that a higher withdrawal rate (closer to 5%) may be possible in the early, active retirement years if later withdrawals grow more slowly than inflation. Others contend that portfolios can last longer by adding asset classes and freezing the withdrawal amount during years of poor performance. By doing so, they argue, “safe” initial withdrawal rates above 5% might be possible. (Sources: William P. Bengen, “Determining Withdrawal Rates Using Historical Data,” Journal of Financial Planning, October 1994; Jonathan Guyton, “Decision Rules and Portfolio Management for Retirees; Is the ‘Safe’ Initial Withdrawal Rates Too Safe?” Journal of Financial Planning, October 2004)
Still other experts suggest that our current environment of lower government bond yields may warrant a lower withdrawal rate, around 3%. (Source: Blanchett, Finke, and Pfau, “Low Bond Yields and Safe Portfolio Withdrawal Rates,” Journal of Wealth Management, Fall 2013)
Don’t forget that these hypotheses were based on historical data about various types of investments, and past results don’t guarantee future performance.
An initial withdrawal rate of, say, 4% may seem relatively low, particularly if you have a large portfolio. However, if your initial withdrawal rate is too high, it can increase the chances that your portfolio will be exhausted too quickly, because you’ll need to withdraw a greater amount of money each year from your portfolio just to keep up with inflation and preserve the same purchasing power over time.
In addition, inflation may have a greater impact on retirees. That’s because costs for some services, such as health care and food, have risen more dramatically than the Consumer price Index (the basic inflation measure) for several years. As these costs may represent disproportionate share of their budgets, retirees may experience higher inflation costs than younger people, and therefore might need to keep initial withdrawal rates relatively modest.
There is no standing rule of thumb. Every individual has unique retirement goals and means, and your withdrawal rate needs to be tailored to your particular circumstances, the higher your withdrawal rate on your portfolio, the more you’ll have to consider whether it is sustainable over the long term.
If you have questions or feel that we may be able to help with any part of your retirement plan don’t hesitate to call.
Jeff Christian CFP, CRPC