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Withdrawal Rates, Educated Decisions and You

May 08, 2020
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Perhaps one of the most frequently asked questions we receive when discussing retirement is “How much money can I withdraw and when can I start?” This is a terrific question and is exciting to hear because it is indicative of focus, dedication, and the desire to make the educated decisions about the future for yourself, loved ones, and others affected by your philanthropic and charitable gifting.

Long has been the understanding that, generally, a "safe" withdrawal rate throughout retirement is ~4% of retirement assets. Now, the “4% rule” runs on general assumptions and, unfortunately, there is no quick-and-dirty way to determine a suitable personalized withdrawal rate. Risk tolerance, a gradual increase/decrease of real spending, inflation assumptions, ability to flex annual spending, and amount of guaranteed income are just a handful of factors that must be considered in determining an initial withdrawal rate. There is no substitute for a customized financial plan tailored to your situation, updated over time to reflect important changes in your life.

Importance of a "Safe" Withdrawal Rate

The amount of income derived from assets to supplement retirement plays a critical role in retirement independence and emotion. You have been a diligent saver for years, is not it time you enjoyed the fruits of your labor? Why should your spending be limited? It is time to celebrate! Well, as with most things in life there is a fine balance, one that is not easy to find and is important to understand.

Excessive drawing on assets beyond your personalized withdrawal rate increases the risk of depleting retirement assets before end of life. In extreme cases this can lead to uncomfortable adjustments in lifestyle and living arrangements at a point in your life where these adjustments are least desired, both by yourself and your family. In contrast, an overly conservative approach to finding a personal withdrawal rate may lead to a relatively restricted lifestyle, beyond what is necessary. Most of the time neither of these outcomes is desirable and depends on factors that are specific to you and your situation.

Factors to Consider

As stated earlier, your situation is unique to you and your risk tolerance. This uniqueness leads to an initial withdrawal rate that is imperative to the financial plan and potential retirement success. You can calculate your withdrawal rate with the following equation:

(Total Expenses ‒ Total Income) ÷ Assets × 100 = Withdrawal Percentage

A critical factor in determining this rate is the amount of money you must draw to cover expenses and meet your desired lifestyle. Expenses can be broken down into three distinct categories: mandatory perpetual (utilities, insurance, groceries), mandatory non-perpetual (mortgage, car payment), and discretionary (vacations, dining). Knowing that these categories will vary through time, your ability or willingness to adjust discretionary spending with market conditions may allow for an increased initial safe withdrawal rate.

Another important consideration is the amount of guaranteed income that you can rely on to offset your expenses. Guaranteed income sources are not subject to market fluctuations; therefore, they can increase retirement security. These sources may include pensions, Social Security, annuities, royalties, etc. An increased amount of guaranteed income flows, keeping expenses constant, decreases the withdrawal rate needed to supplement lifestyle. More risk-averse investors might prefer to have 80% or more of all expenses covered by guaranteed income sources, allowing them to take less risk with their investable assets. Risk-tolerant investors might be comfortable with only 50% of mandatory expenses covered through guaranteed sources, making up the difference by taking on more risk with their investable assets.

Your risk tolerance for success and time horizon are additional factors that must be considered. Someone who is comfortable with an 85% chance of their assets lasting throughout retirement would be able to draw more income than someone who requires 100% chance. Someone retiring at 55 years old will have a different withdrawal rate than someone retiring at 65 years old, given that both expect to live to age 90. Additionally, the former will require a slightly higher equity exposure than the latter.

By now I am sure you can see why there is no quick-and-dirty way to reach a personalized withdrawal rate. Sure, you can apply a standard “percentage rule.” However, it is our belief that you deserve clear, calculated, confident advice that takes into consideration your uniqueness and values. Nobody knows better than yourself the hard work and sacrifice you have endured to get where you are today. We want you to go forward with a sense of confidence knowing that you are making educated decisions.

Actions You Can Take

“This is all great but what actions can I take right now, if any?” Great question. This is something we like to review at least annually and is even more important to review during times of volatility and increased uncertainty. Below is “homework” intended to help you better understand where you are and what changes can be made.

  • Categorize your expenses into three categories, examples are given with each.
    • Mandatory Perpetual (as implied, these are expenses that are required for you to survive and will last for the entirety of your life)
      • Utilities, home and auto insurance, groceries, auto maintenance, health insurance
    • Mandatory Non-Perpetual (these are also required, but will not last for the entirety of your life)
      • Mortgage payment, car payment, term life insurance, other loan payments
    • Discretionary (everything else should fall under this category)
      • Birthday gifts, “mad money”, vacations, dining out
  • Determine how much you could comfortably reduce your discretionary expenses and for how long you would be willing to make that change. 
  • Next, put together a list of all your expected (or current) sources of income. Log on to gov and get your projections for Social Security income. Do you have any annuities, royalties, pensions, or other sources of guaranteed income that you can rely on? How much income will they provide?
  • Finally, and most importantly, spend some time and dive deep into what your goals are in retirement. Do you want to travel more? Give charitably? Secure a legacy for the next generation? Take up that hobby you always wanted to pursue?

You deserve a plan exclusive to you and your situation. Use this information as a starting point and work with your trusted financial planner to determine the best course of action for both the present and future.

“Give me six hours to chop down a tree and I will spend the first four sharpening the axe.”

– Abraham Lincoln

This is meant to be general, and it is not investment or financial advice or a specific recommendation of any kind. The information is based on data gathered from what we believe are reliable sources. It is not guaranteed by Waddell & Reed, Inc. as to the accuracy and is not intended to be used as the basis for any investment decisions. Opinions and forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results could differ materially from those anticipated. Please consult your financial Advisor before making financial decisions. Guarantees are based on the financial strength and claims paying ability of the issuing insurance company.  (05/20)