Retirees need to have a reliable source of income. Retirees who have depleted their retirement funds must obtain income from other sources or, if possible, return to work. However, you can protect your retirement savings from spending them down too quickly by calculating a safe withdrawal rate correctly.
A safe withdrawal rate:
- Avoids running out of money in retirement.
- Accounts for the up-and-down stock market.
- Depends on the risk exposure of the account holdings
- It can be used to pay for retirement expenses.
Safe Withdrawal Rate
An annual safe withdrawal rate is the maximum percentage a retiree can withdraw from an investment portfolio without depleting the account. A retiree who has determined a safe withdrawal rate can then plan a reliable household budget for retirement that may last more than 30 years.
How to Calculate a Safe Withdrawal Rate
As with the 4% retirement withdrawal rule, the safe withdrawal rate model typically results in retirees withdrawing between 3% and 4% of their retirement investment funds annually. For instance, a 60% stock and 40% bond retirement portfolio allows for a 4% withdrawal rate that is very likely to provide sufficient funds to endure a 30-year retirement. You could invest 60% of your money in the S&P 500 and 40% in an A+ corporate bond fund, according to Oak View Law Group attorney Lyle Solomon. Since you only need to collect the money, it’s a straightforward situation.
According to this withdrawal protocol, you would withdraw 4% in the first year of retirement and increase it by inflation each year.
A $100,000 nest egg would look like this:
- Year 1: 4% ( $100,000 nest egg) is $4,000.
- Year 2: 3% inflation rate, you would withdraw $4,120.
- Year 3: 2% inflation rate, you would withdraw $4,202.
Retirees can adjust their withdrawals based on stock market performance, so they don’t have to withdraw precisely 4% each year. When the value of your retirement nest egg drops from year to year, you may want to reset your withdrawal rate. Solomon suggests resetting the year and withdrawing 4% of what’s left if that happens. Alternatively, you could increase your withdrawal rate if your nest egg is growing rapidly.
Safe Withdrawal Rate Strategy: Pros and Cons
Like any investment management strategy, safe withdrawal rates have both upsides and downsides. According to Paul Tyler, chief marketing officer of Nassau Financial Group in Hartford, Connecticut, the safe withdrawal rate method’s primary benefit is that it’s easy to understand and encourages people to control their expenses. In retirement, controlling expenses is perhaps the most critical lever.
One of the most significant risks of using the safe withdrawal rate strategy is that everyone’s definition of a safe withdrawal rate differs. Tyler asks if you decided to withdraw 4%, do you keep withdrawing this amount forever? What if the stock market drops and the value of your account drops as well? Those are the questions a retiree should ask their trusted investment advisor.
What Is Retirement Withdrawal Rate Right for You?
Getting help from a retirement planner is the first step to determining your safe withdrawal rate. A good money manager needs to look at your expenses and other sources of retirement income in order to develop a plan that suits your needs. According to Solomon, retirees must establish a safe retirement withdrawal rate based on factors such as their expected lifespan, portfolio size, outgoing costs, and the amount of retirement income they receive already.
Identifying your financial needs is the first step. Determine how much of your expenses will be covered by Social Security, a pension, or other sources of retirement income. Take your life expectancy and any health concerns into account, perhaps using a life expectancy calculator. When withdrawing from your retirement accounts, you should also consider tax efficiency. Tyler recommends reviewing that plan every year.