Many retirees use the 4% rule to plan their retirement expenses. The 4% rule, based on research by Bill Bengen, suggests that you can safely withdraw 4% of the starting value of your portfolio for 30 years without running out of money.
Bengen used historical data from 1994 to find the highest withdrawal rate that survived 100% of cases, and its safe withdrawal rate of 4% has held since. But do you really need 100% certainty to retire?
What does Safe Withdrawal Rate protect against?
A safe withdrawal rate, such as 4% for a 30-year retirement, is designed to protect retirees against a bad run of returns early in retirement. The first decade of retirement is the riskiest time because a few bad years, combined with regular withdrawals, can quickly reduce a nest egg to an unsustainable level.
The advantage of this reality is that you will know fairly quickly if your pension plan needs to be adjusted. If you can reduce your expenses or find new sources of income, you can reduce your withdrawals and allow your portfolio to recover from a market downturn.
If you have the slightest wiggle room to reduce your expenses, you should be able to afford a higher withdrawal rate which may require some adjustments along the way. That might mean spending more on luxuries early in retirement, like a nice vacation, knowing that you might have to stay home for a few years if a prolonged stock market crash eats away at your retirement funds.
If you delay Social Security, you could withdraw more of your investment portfolio early in retirement, then use Social Security income to reduce withdrawals from your retirement portfolio later, if necessary. In fact, this strategy should provide better protection against a bad return streak because Social Security deferral returns are very predictable.
It is important to note that the vast majority of the time, following a safe withdrawal rate with a very high success percentage (like the 4% rule) will result in a much larger portfolio than the one you started out with. the end of the retreat. This is even after spending money for 30 years.
How and when to make adjustments
There are a few strategies you can implement if you need to adjust your withdrawal rate and reduce (or increase) your expenses. The first is simple.
Any year in which your portfolio loses value, avoid adjusting for inflation the following year. This will allow you to start with a higher initial withdrawal rate, and you probably won’t notice the reduction in actual spending in most years.
The second option is to use guardrails on your withdrawal rate. An example of the guardrail method is to increase your withdrawal rate by 10% when it drops below 80% of your initial rate, or decrease it by 10% when it exceeds 120%.
Let’s say someone uses the above guardrails, has a $1 million portfolio, an initial withdrawal rate of 5%, and experiences inflation of 2% per year. At the start of retirement, they withdraw $50,000 to live on. Unfortunately, the market goes down that first year and their portfolio loses $100,000 in value, leaving them with only $850,000 after making the withdrawal.
At the beginning of the following year, the initial withdrawal of $50,000 is adjusted by 2% for inflation to $51,000. But $51,000 is 6% of the $850,000 portfolio. 6% is the top railing – 120% of the initial shrinkage rate. Thus, the withdrawal amount is adjusted downward by 10% to $45,900. This amount will be adjusted for inflation at the start of the third year and the same calculation will determine if it also needs a railing adjustment.
If you can stay flexible in retirement, you may be able to enjoy a much higher withdrawal rate, with a small chance of having to adjust some things early on. Good contingency plans that allow you to reduce withdrawals, if needed, can help make your retirement much more enjoyable.