A common topic of conversation amongst middle-aged Americans or those approaching retirement age is the topic of income during retirement. One of the most intriguing topics that we believe can help determine your retirement income is called the safe withdrawal rate.
A safe withdrawal rate is the dollar amount you can withdraw freely each year from your investment accounts without the concern of running out of funds before you die. This withdrawal essentially replaces your “paycheck” that you would have received if you were working, and it is an important number to know for your wealth management purposes. If you are approaching retirement, this idea might be weighing heavy in the back of your mind.
The general consensus on the subject is that individuals planning for retirement can safely withdraw 3-4% of their investment funds each year and have a healthy 30-year retirement. If you’re feeling lost, let us give a little guidance on what you should know about safe withdrawal rates to make an informed decision:
What exactly is a safe withdrawal rate?
The percentage from your invested assets that you can withdraw comfortably each year from your investment assets while retired is considered your safe withdrawal rate. For instance, if you have one million dollars saved up for retirement when you retire, and your investment advisor tells you 4% is your safe withdrawal rate, then you can take out $40,000/year (4% of one million), and feel comfortable you will not run out of money before you die.
This should make intuitive sense to some. Consider a one million dollar account that has gained no interest and has no growth to the principal each year. If you withdraw $40,000 per year from this account it will last you 25 years (4% * 25 years = 100% of your assets). If you add a little bit of interest to this account, suddenly, lasting 30 years does not sound so far off, does it? The downside of this example is that it does not take inflation into account. $40,000 10 years form now will not buy you nearly as many things as $40,000 today.
What we believe is fascinating about safe withdrawal rates is that you can adjust your withdrawals along with inflation. Say you take out $40,000 within the first year, with inflation at 3%. The following year, you should be able to safely take out $41,200 from your investment accounts, and so on.
The real headache of using safe withdrawal rates as a retirement income strategy is that you need to monitor your withdrawals against the value of your investment accounts and be able to adapt accordingly.
Why should I monitor my withdrawal rate?
If you are not careful with your withdrawals from your retirement accounts, you may outlive your savings. If you choose a 10% rate of withdrawal as a 60-year-old, you will likely run out of money unless you are planning on not living on much past age 70. On the other hand, if the market plummets and economic conditions change, even a 4% withdrawal rate might be too high for a 65-year-old.
Going into retirement, you should consult with your financial advisor to come up with a safe withdrawal rate that will last you throughout retirement. Each year you and your financial advisor should take a look at the value of your investment accounts and compare them to your withdrawal rate from your investment accounts to ensure that everything is on track with your original plan and life expectancy. During each annual check-in, you may need to alter the withdrawal rate, depending on your investment values, your personal spending needs, and market conditions.
Real life examples using a fixed safe withdrawal rate strategy:
Let’s start by saying you have one million dollars saved up for retirement when you retire, and your investment advisor tells you 4% is your safe withdrawal rate based on your savings and investment risk. With that in mind, you can comfortably take out $40,000 (4% * 1 million). Once you withdraw your 40,000, your investment account value will drop to $960,000 total.
In your annual financial review, you realize that your investment account has actually risen in value to 1.1 million dollars because of a great year in the market year. You can, therefore, take out $40,000 plus inflation safely.
Next year the market plummets and your account is only worth $950,000k during your annual check-in. How much can you withdraw this year? Using the strategy above, $40,000 plus inflation is still a safe amount! This example demonstrates the beauty of academic research in this area. All else equal, once you determine a safe rate of withdrawal, you can generally stick with it throughout retirement even when the market goes down. That said, there are circumstances that can dictate a new analysis of a safe withdrawal rate for you.
For example, assume in the situation above that your investments plummet to $800,000 in your third year of retirement because of various economic conditions. At this point, a financial advisor might suggest that you lower your withdrawal rate to say $32,000 (4% * $800,000) until the economy heats back up. Likewise, once the economy heats up, and your account value is 1.2 million, the same advisor might suggest that you can start withdrawing as much as $48,000 (4% * 1.2 Million).
How can I add flexibility to my safe withdrawal rate?
A safe withdrawal rate usually takes flexible life expectancies into consideration, as this can vary throughout retirement. The older you get, the higher your safe withdrawal rate can become (also taking the value of your portfolio and your needs into your account). For example, a 90-year-old with one million dollars left in their investment accounts can likely exceed the normal 4% safe withdrawal rate. Under the right circumstances, so too might an 80-year-old individual. Your financial advisor should pay close attention to your withdrawal rates, your investments, and your personal situation, and advise you on the safe amount to withdraw each year.
There are various safe withdrawal strategies you can explore. There is a “fixed rate” strategy as demonstrated above, a dynamic rate that adjusts the income you get each year not just with inflation, but with the value of your investments, and fixed income ladders (like Bond, CD, or TIP ladders) that can be used to make the level of income you get more streamlined and less risky.
The most important aspect to safe withdrawals is to check in annually to ensure the amount your withdrawal rate and spending aligns with your current investments. At Morris Financial Concepts, our financial advisors take a hands-on approach to ensure our clients are meeting their retirement needs. To inquire about more information regarding retirement planning, contact us to speak to one of our associates.
Morris Financial Concepts, Inc. is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Morris including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request. MFC-19-08.