If you haven’t heard estimates of the “safe withdrawal rate” as it pertains to your retirement, it’s good to contemplate that now so you can set your retirement plans accordingly. Essentially, there’s a set value of money one can save such that they can withdraw the same percentage each year and never run out. Here we’ll take a look at the common 4-percent assumption, where it came from, and whether it’s too safe or risky.
Withdrawal Rate Considerations
Let’s assume your typical annual spending is £30,000. In order to be able to withdraw that amount each and every year while only drawing down an account by 4 percent, you’d need £750,000. That sounds like a huge number, but it excludes pensions and any other fixed income you may be entitled to later in life. Those amounts could be backed out, so perhaps you only really need £10,000 each year (save £250,000 then). Either way, you get the idea on the withdrawal rate. The reason 4 percent is typically used is economists have looked back at prior stock market returns and assume, roughly, that you can earn 7 percent in a balanced portfolio over time and if inflation is 3 percent, then you could withdraw 4 percent each year and still maintain the same balance in the account (accounting for inflation). Here are some pros and cons to assuming a 4-percent withdrawal rate will actually sustain you during retirement.
Problems With the 4 Percent Withdrawal Rate
- Market Timing – One of the biggest problems looking back historically is that the allowed withdrawal rate depends very much on when you started investing (or when you retire). If you started just before an upswing in the stock market you did great and probably could have withdrawn 5 percent or more without running out of money. However, if you invested at the peak and the market crashed right when you started withdrawing, you would have needed more money saved.
- Spending Uncertainty – Using a steady withdrawal formula assumes your costs will remain roughly the same as they are now. But what if you want to travel a lot or have certain other expenses?
Benefits of the 4 Percent Withdrawal Rate
- Easy to Estimate – since 4 percent is 1/25, you can easily target how much money you’d need to have in your retirement account to rely on the 4-percent rule. With this knowledge you can quickly know that being able to withdraw £10,000 annually requires having £250,000 saved. This is much easier to do and remember than using complicated spreadsheets or financial planners.
- May Be Conservative – While some people may see a spending increase in retirement, the reality is that most people actually end up spending less in retirement, especially in very old age. Additionally, many people become eligible for more government services with age.