Withdraw 4% in Retirement?Submitted by Larry Frank Sr. on Wed, 07/11/2012 - 12:00pmThe 4% rule for retirement income says you can safely withdraw thatamount of your portfolio value each year when retired. For example, foreach $100,000 you have in your retirement accounts, you can withdraw4% or $4,000 per year (or $333.33 per month). But the longer you live,the more money you can remove without depleting our assets. So youcan withdraw above 4% as you move deeper into retirement.The 4% rule applies to early retirement years in general, but does not fitolder ages. The rule was also originally developed using 3% inflationadded to the “initial” withdrawal dollar amount each year. Thus, theinflation adjustment for the example above would be $4,120 for thesecond year, $4,244 for the third year and so on.This creates a problem where the benefit paid is disconnected from theactual value of the retirement portfolio that is supposed to support thepayment (much like pensions and annuities) and may lead todramatically reduced portfolio balances. Instead, a real withdrawalamount – one that factors in inflation – should be used each year wherethe real rate is applied to the actual value of the retirement portfolio.Therefore, the benefit paid and the actual portfolio values remainconnected.We’ll go into the particulars in a minute. Look at the top third of the chartfor the three groups: 1) Consumption(where the simulated lifespan, ortime period used for this year’s simulations for the current age, isshortest and retirees remove more money), 2) Expected (traditionallifespan expectations are used in the simulations and retirees withdraw”normally”) and 3) Bequest (the longest simulated lifespans are used inthe this year’s simulations and retirees are even more careful about howmuch they take out).The older you get without dying, the more years you are likely to live.Any calculation needs to have a time frame over which the calculation
covers. Simulations are no different. But how long a person might live isuncertain. Therefore, longevity tables use percentiles to help determinethe length of certain possible lifespans. The bottom two-thirds of thechart show how many years each group used in the simulations for eachage, and to what age they take the retiree.As they age, they can safely take out more money from their retirementaccounts. So a 60-year-old in the Consumption group can withdraw4.66% per year. By 80, he can remove 10.53%.These conclusions come from peer-reviewed research – publishedMarch 2012 in the Journal of Financial Planning by me and mycollaborators, John Mitchell from the University of Central Michigan andDavid Blanchett from Morningstar.The figure above is based on a 60% equity, 40% bond allocation. Ipicked this allocation because withdrawal rates may be slightly higher formore conservative allocations so these may be interpreted asreasonable rates. More aggressive allocations tend to have lowerwithdrawal rates.The figure shows the three groups, or as we call them, objectivesbecause the numbers measure how much people plan to take out, whenand under what assumptions. The Expected lifespan is what people thinkabout when they talk about longevity. The Expected objective usesexpected longevity from the Social Security period life tables (joint). Thisis where 50% of the population at the given age outlives the expectedlifespan, which is an average so it’s reasonable that half the age cohortwill outlive that number. That is why some people get to be very old. Wejust don’t know, though, if we will be one who outlives the period or notuntil we get to that older age.The Consumption objective sets the longevity time frame such that 75%of the people at the stated age outlivethe shorter simulated lifespan. Inother words, the time period from the table is shorter than expected. Whywould a retiree use a shorter than expected period?For two reasons: First, and more importantly, a shorter period allows fora higher consumption (hence the label Consumption). This may be arealistic objective to spend more during the early years of retirement andthen reduce spending later in retirement. Now, this objective can bemeasured and monitored. Second, the simulated period is onlytemporary. The older you get, the longer your expected lifespan is. In thefigure above, at age 60 the simulated lifespan is 24 years to age 84. Inplanning for the future, the retiree only uses that number for a few years,and then they adjust to lifespans based on expected longevity, forexample (the yellow shading).
Spending more early comes with a cost, though. Your portfolio value isreduced faster by spending more, which means that later portfolio valuesare less than they would be using Expected time frames (or even theBequest time frames discussed later). So, even though the withdrawalrates can go up slowly at later ages, the portfolio values are lower with theresult of less monthly income at those later ages. The longer the higherconsumption rates are used, the stronger this effect.Lastly, the Bequest objective determines the time period from thelongevity table for each age based on the time frame where 25% of thepopulation outlives the simulated lifespan (blue highlight that transitions toyellow). This results in longer than expected lifespans andtherefore lower withdrawal rates. Now, a retiree can measure anddetermine a retirement supplement income and have portfolio valuesdeplete at a much lower rate for either their bequest wishes, or to retainthe assets for their health, or other needs, later in their retirement years. Inother words, this has the opposite effect from Consumption discussedabove; and Expected is the mid-point between these two measurablegoals.Note that a withdrawal rate near 4% in the figure is found near age 60 ingeneral. The rate increases past age 65 and older because the simulatedlifespan slowly gets shorter as retirees age. In other words, now there aredifferent rates for different retiree goals and situations which are muchmore realistic than shoehorning all retirees into one 4% rule.A general observation from the figure above is that both time periods andwithdrawal rates change as the retiree ages. Each retiree may choosewhich strategy to use, and may change the strategy as they age. Indeed,changing from Consumption, through Expected, to Bequest is suggestedto have some portfolio value preserved for the possibility of getting evenolder. Also, even a Bequest goal may temporarily change to theConsumption goal for a year or two, and now with a measurable methodof how to do that, and then change back again.My message: Each year is determined separately as opposed to theclassic thought of set-and-forget retirement. Life and retirementwithdrawals are more dynamic than set-and-forget. The abovedemonstrates that there is a range of choices between which you caninterpolate each year. For example, if you are a 65-year-old retiree, youmay withdraw between 4.11 and 5.29% of your current portfolio balancedepending on your overall objective to consume or conserve yourportfolio. The withdrawal percentage changes each year you age. And,when you reach 80, you may withdraw between 6.35% and 10.53% of theportfolio balance (we don’t know what that value might be when you are80 because nobody knows what any market might do over the next 15years).Also, notice the older a retiree gets, the older they are expected to live.For example, in their 60s a retiree’s (joint) expectations are about 90 whilein their 80s expectations have changed to late 90s. Males and females assingles would have slightly younger ages than those above, so using joint
ages makes the time period slightly longer, which makes the withdrawalrates illustrated conservative.Finally, all the calculations were based on 10% of the simulations (MonteCarlo method) not reaching the end of the period. This last point leads tothe subject of my next article: How to measure your retirement when themarkets go down, and when to make a decision about what to do whenthat happens.Note: Withdrawal rates reflect a temporary percentage that may beremoved from a portfolio given a specific set of parameters at thatspecific moment in time; they are not rates of returns.The above article is third in a retirement series. The first seriesarticle: Retirement Planning Mistakes. The second series article: MovingYour Retirement Goal Posts? Other articles for the not-yet-retired: InWhat Should the Young Invest? And Consistent Savings Tops Returns.Follow AdviceIQ on Twitter at @adviceiq.Larry R Frank Sr., CFP, is a Registered Investment Adviser (California) inRoseville, Calif. He is the author of the book, Wealth Odyssey. He has anMBA with a finance concentration and B.S. cum laude in physics withwhich he views the world of money dynamically. He has peer-reviewedresearch published in the Journal of FinancialPlanning. www.blog.BetterFinancialEducation.com.AdviceIQ delivers quality personal finance articles by both financialadvisors and AdviceIQ editors. It ranks advisors in your area by specialty.For instance, the rankings this week measure the number of clientswhose income is between $250,000 and $500,000 with that advisor.AdviceIQ also vets ranked advisors so only those with pristineregulatory histories can participate. AdviceIQ was launched Jan. 9, 2012,by veteran Wall Street executives, editors and technologists. Right now,investors may see many advisor rankings, although in some areas only afew are ranked. Check back often as thousands of advisors areundergoing AdviceIQ screening. New advisors appear in rankings daily.Topic:Retirement PlanningSpendingWithdrawals from 401Ks