Beacon Financial Strategies

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A Rule of Thumb for Withdrawal Rates

We are often asked the question - “How much money I can withdraw from my accounts during retirement and be guaranteed not to deplete them?”  That question is full of pitfalls because retirement has so many unknowns: life expectancy, health care costs, and inflation among others.  And while we don’t advocate for a rule of thumb in place of a retirement plan, we can see the benefit of utilizing one as a periodic checkup or affirmation. 

With that in mind, T. Rowe Price has a study analyzing the sustainability of portfolio withdrawal rates based on the stock to bond mix (asset allocation) of a portfolio.  In their study, T. Rowe Price conducts a statistical analysis using thousands of simulated outcomes.  The outcomes are based on varying economic conditions and the historical returns of both stocks and bonds.  For each stock/bond mix, the analysis calculates a “Likelihood of Success” which is the probability that a withdrawal rate is sustainable given that allocation. 

As you will note from the table below, higher withdrawal rates reduces the likelihood that an investment portfolio will last throughout an extended retirement period.

So, for example, let’s say you expect your retirement to last 30 years and your portfolio allocation is 60% stocks and 40% bonds.  With a 4% withdrawal rate, your assets have a 87% chance of lasting for the entire 30 year retirement period.

Observations

  • The stock/bond mix is critical.  From our experience, the asset allocation of a portfolio for the 5 years preceding retirement and the first 5 years of retirement plays a huge part in the probability of success.  For example, a portfolio invested too aggressively, may result in a sharp decline in portfolio value.  This decline in portfolio value would reduce the amount that could safely be withdrawn without fear of depletion.  

  • Withdrawal rates should be net of income taxes.  This is no small factor considering IRAs, Roth IRAs, personal brokerage accounts, and annuities are each taxed differently.  Making tax-efficient withdrawal decisions is essential in increasing the probability that your entire retirement can be safely funded. 

  • Financial hardships should be a consideration.  In our experience, very few people have a no-frills retirement.  There are always financial “curve balls” that need to be considered and incorporated into a retirement feasibility analysis.   Unexpected medical expenses or long term nursing care could severely impede the likelihood that retirement assets would outlast you.  

A rule of thumb does not replace a well thought out plan, but it does offer a starting point when thinking about withdrawal rates in the overall context of your plan.  And it can be used as a check up to see how far you have progressed toward your goals.  We are happy to consult with you on your retirement plan and distribution strategies and calculate your current and future withdrawal rates.