Prudent Withdrawal Rate - Rodgers & Associates

Prudent Withdrawal Rate

Tom Lauricella’s column last week in the Wall Street Journal questions the relia­bility of being able to withdrawal 4% to 5% from your portfolio throughout retirement. See “Why Your Nest Egg May Not Last.” 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 column quotes a new study from Ed Easterling’s book Probable Outcomes that shows the 95% proba­bility of success for a 4% withdrawal dropping to 76% if you retire when stocks are in the top 20% of their historic valuation.

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’s going on with the portfolio. A 76% proba­bility of success is an acceptable projection when you’re monitoring the portfolio. Minor adjust­ments can easily be made long before the portfolio is at risk of being depleted which will 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 if necessary in a down market.