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