A successful retirement story is a tale of two parts: building a comfortable nest egg and spending an appropriate amount to make it last. Fortunately, your withdrawal rate in retirement is something you control, and you can use it as a crucial lever to avoid outliving your money.
A safe withdrawal rate can help you strike a balance between living the life you’ve always wanted and not going broke in the process. And, the best way to play it safe is to be flexible.
What is a safe withdrawal rate?
Safe withdrawal rates differ for everyone. The percentage of your savings that can be sustainably spent each year in retirement depends on many personal factors: your level of wealth, annual expenses, sources of guaranteed income (pensions, Social Security, etc.), age when you retire and market conditions.
Financial advisers can provide detailed assessments by using financial planning software that run thousands of simulations to show how your portfolio would hold up under a variety of scenarios. Essentially, you can learn the probability of your portfolio surviving under different withdrawal rates and then choose the rate most comfortable for you.
The common withdrawal rule
A general rule of thumb is the so-called “4% rule.” This rule was popularized by two studies (here and here) that suggested a retirement portfolio comprised of 50% stocks and 50% bonds would last 30 years if you withdraw 4% in your first year of retirement and then adjust that percentage annually for inflation.
While the 4% rule is a good starting point during the retirement planning process, there are reasons why it shouldn’t be considered a steadfast rule. For instance, your personal needs may unexpectedly change during retirement.
In addition, this rule was created using historical data, so it may no longer work under future market conditions when you retire. For example, today’s historically low interest rates have tempered bond returns, reducing their capability as an income source. Other market conditions, such as extreme fluctuations or high valuations, can also make it difficult for retirees to generate enough growth to support a 4% withdrawal rate.
On the flip side, a 4% withdrawal rate, depending on the size of your portfolio, may be too low and could leave you with too much money. Almost as bad as running out of money is sacrificing the things you planned to do by living more frugally than you have to. As they say, no one wants to be the richest person in the graveyard.
A flexible withdrawal rate
The best way to adapt to personal and market changes in retirement is to be flexible with your withdrawal rate. Consider it your power to rewrite your retirement story as your life or the financial setting changes.
You may have to withdraw a higher percentage to take that overseas vacation, or if you experience unexpected medical bills and home repairs. Conversely, you may choose to scale back during a prolonged bear market, as long as your necessary expenses are covered.
A balanced and well-diversified portfolio should provide the growth and preservation over the long term. It’s a flexible withdrawal rate that will then help you improve the likelihood you have a safe retirement, which makes for a good story and life fully lived.