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A Rules-Based Approach to Retirement Income Withdrawal

The best approach to have an initial retirement income withdrawal rate above the recommended 4% Safe Withdrawal Rate (SWR) (assuming you are willing to periodically adjust your withdrawals when the markets warrant it) is detailed in Ben Stein’s and Phil DeMuth’s 2005 book, Yes, You Can Still Retire Comfortably!: The Baby-Boom Retirement Crisis and How to Beat It. The author’s propose a simple and straight forward “rules-based” approach to retirement income withdrawal. I will briefly describe it.

When considering increasing your initial withdrawal rate, one thing you should keep in mind, is that this approach almost assuredly means that the value of your estate will be smaller upon your death, thereby leaving fewer assets to your heirs. Because my wife and I have no children, this is not a particular problem for us. However, other couples may feel differently about leaving an estate to their children.

Ben Stein and Phil DeMuth’s approach is to break up your retirement into a succession of 5-year periods. At the beginning of each 5-year period, the retiree needs to re-evaluate and adjust his/her withdrawal rate. The changes to your withdrawal rate will depend on three things, how your portfolio has performed, the inflation rate, and the number of years left in retirement. Below is a table of the recommended SWR rates based on the number of years in left retirement.

Retirement Years vs Initial Withdrawals Rates

Calculations based on FireCalc.com algorithm

Assumptions:

-Based on 50%/50% equity/fixed income ratio, rebalanced annually

-Average annual portfolio management fees = 0.50%

-Annual withdrawals are inflation-adjusted based on CPI

-90% probability of portfolio survival

Here is their approach:

• Estimate your length of retirement years using the estimated life expectancy of the surviving spouse as your no. of years in retirement. Let’s assume that you decide on a 35 year retirement.
• From the table above 35 years would indicate that a 3.8% withdrawal rate would make reasonably certain that you will not run out of assets before you run out of life. Personally I think anyone retiring at 65, using a 3.8% withdrawal rate would be very safe.

But if you have only a $500,000 portfolio, then 3.8% means you can only initially withdraw about $19,000 per year adjusted for inflation thereafter. But let’s say you wish to live on $24,000 in your first year of retirement. This represents a 4.8% initial withdrawal rate from a $500,000 portfolio.

• If you are willing to accept the higher risk of portfolio failure, you can go ahead and withdraw the first year’s 4.8% initial rate.  Years 2 through 5 withdrawals will be the original $24,000 withdrawal increased by the annual inflation. (Ideally, these withdrawal amounts are set up in advance as a 4-year fixed income ladder as described in this earlier post).
• If, in any year during this first 5-year period your portfolio suffers a significant loss, then you should return to your original SWR as indicated in the above table. In this example, if in year 3 your portfolio suffered as significant loss, you would return to a 3.8% withdrawal rate in year 4. You would then increase this new lower withdrawal rate by the annual inflation rate until you reach year 5 of the current 5-year period.
• At the beginning of each 5-year period, you repeat the process over again. In this example, you would now have only 30 years left in your retirement phase. The above table indicates that a 4.1% withdrawal rate is recommended. Since you prefer to withdraw more in the early years, you, again, choose a 1% higher withdrawal rate. So you start this 2^nd 5-year period at 5.1% adjusted for inflation each year thereafter. If your portfolio balance in year 6 of retirement is $480,000, your initial 5.1% withdrawal amount would be $24,480, slightly more than the $24,000 initial withdrawal rate at the start of retirement.

Of course, if the market had not gone down in the first 5-years period, your withdrawals would have been higher at the beginning of the 2^nd 5-year period. But since the market experienced a down trend in year 3, the prudent thing to do was to lower your withdrawal rate until your portfolio recovers. This is how you maintain your portfolio longevity over your entire retirement period.

• This assessment process should take place at the beginning of every 5-year period. At the beginning of the third 5-year period, you will have only 25 years of retirement left. The above table recommends about a 4.5% withdrawal rate from your current portfolio balance. If you can comfortably live on this, then there is no reason to withdraw more funds and increase your portfolio longevity risk. But if you do need a higher level of income, then you can repeat the previous steps of increasing your withdrawal amount by up to 1% to 5.5% adjusting this amount each year for inflation. You will also need to continue tracking how your portfolio does every year to be sure you do not need to make any mid-course adjustments.

For those who want a simple rules-based approach to take a calculated risk of withdrawing more retirement funds than the recommended initial amount, I think this approach is pretty good. If you follow it precisely, it should keep you out of trouble. But like the last post I wrote, it will likely require some spending flexibility. You may have to spend less money in some years than others, based on market conditions.

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