Through your working years it's second nature for many to set aside a piece of the paycheck for the future. Now that you're reaching the end of your accumulation phase (which are your working years while you grow your retirement account), it's time to set a plan for how you'll withdraw from your retirement accounts. In other words, it's time to build your retirement paycheck.
Unlike your working paychecks, when your retirement account hits zero, they stop. So, retirees face a significant question. What's a safe amount I can withdraw from my retirement accounts, setting the worries aside to focus on the fun?
What is a withdrawal rate?
Put simply, a withdrawal rate is the amount you take out of your retirement account each year, divided by the total beginning balance of the account. Here is an example.
Nest egg: $100,000
Annual withdrawal: $5,000
$5,000 / $100,000 = 5% withdrawal rate
What makes a withdrawal rate safe?
In the financial planning world, a safe withdrawal rate is the percentage of your account you could withdraw in your first year of retirement, adding an annual increase for inflation each year thereafter, and not run out of money in retirement.
Of course, several factors will play a role in how long your money actually lasts, including:
- Stock market returns, particularly downturns
- High inflation
- Low interest rates
- Health or other emergency withdrawals
The range of opinions on safe withdrawal rate
With so many uncertainties and unique circumstances for retirees, it may be no surprise that there is no single best withdrawal rate for everyone. Setting retiree differences aside, it is also true that the assumptions and perspectives from personal financial planning practitioners and researchers varies widely, which yields more of a range of options than a best answer.
Depending on the source, you may find safe or recommended withdrawal rates in a range of 3% to 8%. Dave Ramsey has met criticism for his 8% withdrawal rate, purportedly built on heavy stock investment, strong returns and perhaps not accounting for volatility of returns – a real world risk referred to as sequence of returns risk. Bill Bengen has written about a safe withdrawal rate at 4.5%. A study from Morningstar in 2013 called Estimating the True Cost of Retirement showed lower initial rates of 3% to achieve a 95% confidence your money would last 30 years. Other studies and references with differing results include the "Trinity Study" and the Guyton-Klinger guardrails.
So, what is right for you?
A practical place to begin is with the 4.5% SAFEMAX withdrawal rate from Bill Bengen. While fellow retirement nerd, Michael Kitces, has since calculated these rates could be higher based on market conditions, the highly valued equity markets and potential for increased inflation are two big reasons (as of writing in early 2021) to stay closer to that 4.5% level if you can meet your budget. In following years, add an increase for inflation, and based on historical returns, you're not likely to outlive your retirement nest egg.
Of course, you will have the opportunity to dial your spending up or down in following years as you live your retirement vision. To do this, consider the following list with your loved ones as part of an annual review:
- Longevity, health, access to care and insurance
- Spending in more active years versus less active years of late retirement
- Other assets such as real estate, business interests
- Potential changes to cashflow from death of a spouse - pensions, social security, annuities, etc.
- Assumptions about the investment markets, inflation, taxes and economy
- Your appetite for various risks and asset allocation
I am overwhelmed. Can I get some help?
There is a lot to consider and likely a lot that will change from one year to the next. Therefore working with an advisor can be very valuable. Employees in our retirement plans can discuss personal withdrawal rates with our Retirement Wellness Team, so please give us a call at (949) 757-1799.
In the meantime, the LifePath Spending Tool from BlackRock is a good and simple calculator to help you get started. The inputs you'll have to provide include:
- Current age
- Current savings
- Annual Social Security income
- Portfolio equity allocation
By entering this information an clicking through a couple of pages, you will have a nice retirement income range to consider for future years!
With recommendations ranging from 3% to 8%, determining the ideal rate to draw down your retirement account can be daunting. A practical starting point is Bill Bengen's 4.5% SAFEMAX rate, particularly given the highly priced equity markets and potential for increased inflation in 2021. Talking through a plan with your team at Retirement Wellness Group may help set you off into the next phase with the confidence that allows you to enjoy every minute what is next.
We are here to be your guide so reach out anytime at firstname.lastname@example.org.