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How Much Retirement Income Should You Withdraw? September 2008
In the first few years of retirement, some couples really “live it up” … and some of them risk spending down their retirement savings. Their portfolios aren’t earning enough to make back the income they’re withdrawing.
Some new retirees end up withdrawing as much as 7-10% of their retirement assets annually. A bull market tends to encourage this kind of exuberance. But what happens when one’s portfolio only returns 1-2% this year, or even posts some losses? In short, the ability to continue such high withdrawals could be severely strained.
Ultimately, the answer is highly personal. There is no “standard” retirement income withdrawal rate. Your withdrawal rate should be determined in consultation with your financial advisor, who can help you evaluate some very important matters: your risk tolerance, age and health, lifestyle needs, and all sources of income.
Many new retirees are told that a 4-5% annual withdrawal rate makes sense. If you withdraw 4-5% from your retirement nest egg annually and your investments steadily earn about 5-6% year-to-year, it is quite possible that your invested assets will last a quarter-century or longer given mild inflation.
But that scenario assumes linear rates of return, withdrawal rates, and inflation. Unfortunately, none of these variables are consistent from year to year. This inconsistency is a good reason in and of itself to personalize your retirement lifestyle plan.
Consumer costs. Over the past 50 years, consumer prices have increased (on average) about 4% annually. So you might assume that your portfolio should generate at least a 4% after tax annual return just to help you keep up with the cost of living. But if you retire with that assumption and inflation should spike notably higher, you may need to adjust your withdrawal rate.
Market dips. When you are 35 or 40, your investments have time to rebound from a market downturn. When you are 60 and living off your nest egg, things are different.
Example: let’s say you are 60 years old, and you have $500,000 in your portfolio. All of a sudden, your portfolio has two really bad years: you lose 12% in Year 1 and 7% in Year 2. So at 62, your portfolio is now worth $409,200. You would obviously want to get back to $500,000 or better, but how long would that take? Well, your portfolio would have to gain 22% in Year 3 to get back to that $500,000 level, assuming no withdrawals were being taken.
You can see that even if you weren’t withdrawing money from your portfolio during this time but need to do so at age 62, the numbers look quite different. Assuming a need of $25,000 income from your initial investment of $500,000, your desired/expected withdrawal rate was 5%. Now, given a tough market and a balance of $409,200, your need for $25,000 in annual withdrawals equates to a distribution rate of 6.1%. Such a change might indicate a need for reduced withdrawals during a tough time. But the answer is always dependent upon many personal and economic factors, so there isn’t a one size fits all answer to this dilemma.
The merit of conservative withdrawals. With ongoing improvements in healthcare, today’s retirees stand a good chance of living into their eighties and nineties (and perhaps even longer). This is another good reason to exercise a little moderation when scheduling retirement income.
The wisdom of a retirement income plan. Ideally, you will transition into retirement with the help of a Certified Financial Planner™ professional (CFP®) who will meet with you periodically to review your investments and income needs, and assist in designing a realistic and personalized retirement lifestyle plan---before you actually retire. It is the retirement lifestyle plan that should dictate the appropriate investment strategy, not your desire for a particular rate of return or appetite for risk.
Begin today by taking inventory of your particular personal and financial variables, then start interviewing for a trusted professional to guide you into retirement and beyond. |
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