What’s a safe withdrawal rate these days?

You’ve worked hard for many years and diligently saved a sizable retirement nest egg. You’re now ready to walk away from your job and live off your savings and Social Security. This is a wonderful time in your life. So how much can you pull out of your savings each year and be confident that you won’t run out of money. What do the experts say?

For many years conventional thinking was that a withdrawal rate of 4% was an amount that would all but assure your money would last forever. This was introduced by Bill Bengen in 1994 in a study called Determining Withdrawal Rates Using Historical Data. Here’s how it works. If you are in the 60 to 65 age range and you have a portfolio of 50% stocks and 50% bonds, you can take out 4% the first year. Each year thereafter, you can increase that amount each year by the inflation rate. If you have $1,000,000 and the inflation rate is 3%, you can safely withdraw $40,000 in year 1, $41,200 in year 2, $42,436 in year 3 and so on. You will have to vary your inflation rate each year to match what actually happens. In his study that used historical data, Bengen suggested the 4% rule was safe because all scenarios tested lasted at least 33 years.

Does this still hold true today? My thoughts are that this is too conservative for most people. If you are younger at retirement and conservative by nature, then this may work for you. Even Bengen in a recent podcast said he’s probably be recommending somewhere in the 5.25 to 5.5% range.

Let’s take a look at the reality of withdrawals in retirement. First, no one really manages their money and withdrawals in such a mechanical fashion. There may be times where your spending needs are different and you’ll need more or less money in a given year. Second, his study was looking at a worst-case scenario in market performance. So, it’s applying a very conservative approach to everyone. Third, inflation was very high over the 25 years preceding his study, so his withdrawals increased more each year in his study than what inflation warrants today. Lastly, other studies have shown that spending over retirement actually decreases over time as your consumption of goods and services decrease, especially as you head into your 80’s. This applies to all income ranges. The exception is when someone has expensive healthcare needs and the money to pay for them.

I suggest that it is important to set a withdrawal rate that makes sense for your situation, possibly somewhere in the 5% to 7% range. The higher levels of this range are dependent on having a stash of liquid money (sometimes referred to as emergency funds) that you can live off of for at least 2 years if the market has a decline. That way you can leave your investments alone while they recover. Just a note that when you’re working it’s generally recommended that you have at least 6 months in liquid assets (emergency funds), while I recommend retirees have 24 months. Lastly, if you are able to vary the amount you withdraw each year based on the performance of your portfolio, that will help your money last. As an example, let’s say you choose to take out 7% of the previous year-end value of your portfolio, that will always leave the other 93% to stay invested. If you have a good year investing, your check next year will go up. The opposite happens in a bad year.

In summary, be sure to develop a withdrawal strategy, monitor how it’s going, change it if you have to, and always be aware how large withdrawals or poor market performance can impact you.