Withdrawal Rate

Most retirees want to be able to maintain their standard of living and financial security throughout retirement.  They hope to maximize their income, but they also fear running out of money.  How do they find the right balance between the desire for maximum income while avoiding an early depletion of their portfolio?  That’s one of a retiree’s most pressing financial dilemmas.
Let’s illustrate this puzzle with an example.  Suppose your house is paid for, and you have some guaranteed income in the form of Social Security and a pension.  Fortunately, since this is not enough., you also have some capital, which may consist of an IRA and other savings.  In addition, you may want to leave some for kids, and set aside a reserve for emergencies.  The rest, you can spend guilt free. 

The critical question becomes: “What is the maximum rate at which you can withdraw from your portfolio while meeting the following conditions?” 

• Never requires a reduction in withdrawals from any previous year
• Allows for systematic increases in withdrawals to offset inflation
• Maintains the portfolio’s ability to satisfy the first two conditions for at least 40 years (or for as long as you expect to live)

The rate that meets the above conditions is known as the safe initial withdrawal rate.  The difficulty in identifying this safe withdrawal rate lies in the fact that, if it is set too high, you will run out of money, while if the rate is set too low, you will miss out on the joys of spending.  Furthermore, this rate is affected by many variables, including how long you plan to live (how long you need to draw capital) future inflation rates, the rate of return on your investments, the sequence of returns, volatility and so on. 

Pinpointing this safe withdrawal rate requires projecting one’s cash flow inflows and outflows into the future--a sophisticated calculation requiring precise projections.  For this, I use a program called Naviplan Select. It is, in my opinion, the most comprehensive cash flow projection software on the market.  You can visit their website at www.eisi.com and learn more about their program or just give me a call.

However, to illustrate the complexities of finding the safe initial withdrawal rate, I have put together a simple model that lets you estimate your safe initial withdrawal rate.  For a copy of it, please click here.   Notice the key assumptions needed: how much capital you want to consume in your lifetime, the income you need to generate, your expected longevity, the inflation rate and the rate of return on your investments.  Once you enter these assumptions, the spreadsheet will determine whether your withdrawal rate is sustainable.  It is a wonderful tool to quickly visualize the impact of withdrawal rates on your financial security.

For more information on calculating safe withdrawal rates, call Professor Ulivi at 714-771-6000 or email him at professor@ulivi.com