Prudent Withdrawal Rate - Rodgers & Associates

Prudent Withdrawal Rate

Time and time again, colum­nists have questioned the relia­bility of being able to withdraw 4% to 5% from your portfolio throughout retirement. The so-called “Safe Withdrawal Rate” is from a study done by Trinity University in 1998 that examines the likelihood of a portfolio lasting over various periods of time when you withdraw a fixed percentage and adjust that amount up each year with the rate of inflation. The 4% rule became a rule of thumb when relating to safe retirement withdrawals. If 4% of your retirement savings can cover one year’s worth of retirement spending, you have a high likelihood (over 95% success rate) of having enough money to last a 30+ year retirement. A key point in the study and withdrawal rate is the proba­bil­ities used are just historical frequencies and not a guarantee of the future.

It is important to note that there is no such thing as a truly safe withdrawal rate. Investment returns and inflation are always uncertain. This does not mean that it’s time to abandon the Trinity Study or buy an annuity to guarantee a portion of your income. From a practical stand­point, we do not set up 4% distri­b­u­tions and then ignore what is going on with the portfolio. A 76% proba­bility of success is an acceptable projection when you are monitoring the portfolio on a regular basis. Minor adjust­ments can usually be made long before the portfolio is at risk of being depleted which can increase the likelihood of success.

We advise clients to start their distri­b­ution at no more than 4% of the portfolio value. Then we monitor withdrawals with the objective of avoiding a distri­b­ution rate that exceeds 6% of the portfolio value in down markets. This means that a portfolio would need to lose a third of its value before withdrawals should be reduced. The original amount of withdrawal could be quickly restored as soon as the portfolio value recovers.

I believe the 4% withdrawal rate is still a prudent amount to use to project retirement income from a balanced portfolio. Adjust­ments may need to be made along the way because uncer­tainty will always be with us. The best defense is to always have control of your spending- that way you can quickly trim your spending in a down market, if necessary.

Origi­nally posted April 2011