Retirement Withdrawal Rates
During your working years, you've probably set aside
funds in retirement accounts such as IRAs, 401(k)s,
and other workplace savings plans, as well as in
taxable accounts. Your challenge during retirement is
to convert those savings into an ongoing income
stream that will provide adequate income throughout
your retirement years.
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.
Why is your withdrawal rate important?
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
So, what withdrawal rate should you expect from your 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 Rate 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.
Inflation is a major consideration
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 chance 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 a 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.
Your withdrawal rate
There is no standard 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, the more you'll have to consider
whether it is sustainable over the long term.
All investing involves risk, including the possible loss of principal; there can be no assurance that any investment strategy will be successful.