The fixed percentage withdrawal strategy is the polar opposite of constant inflation-adjusted spending. Subsequent strategies we consider will strive to strike a balance between these two. This fixed percentage strategy calls for retirees to spend a constant percentage of the remaining portfolio balance in each year of retirement.
William Bengen’s 1994 article introduced the concept of the 4% rule for retirement withdrawals. He defined the sustainable spending rate as the percentage of retirement date assets which can be withdrawn, with this amount adjusted for inflation in subsequent years, such that the retirement portfolio is not depleted for at least thirty years.
The 4% rule has a planning horizon of thirty years. But is that a long enough horizon?
Traditional safe withdrawal rate literature regularly makes the assumption that retirees will choose a withdrawal rate that will leave precisely no wealth after the final withdrawal in the thirtieth year of retirement. This can leave them playing a game of chicken as their wealth plummets toward zero.
Because the tax situations of individuals will vary so greatly in terms of tax rates, interest and dividends supported by the portfolio, and the cost-basis of the taxable account, it is impossible to create one general number for a sustainable spending rate from a taxable account.
Another optimistic assumption of classic safe withdrawal rate studies is that retirees are able to earn precisely the underlying index returns net of the risks. But three truths dispute that idea.
The relationship between stock market valuations and sustainable spending rates has great implications for retirement planning when we consider how the pre-retirement savings phase and the post-retirement withdrawal phase can be linked through the stock market valuation level at retirement.
This is a matter where Monte Carlo simulations are able to shine, by allowing simulations to begin from today’s starting point rather than incorporating historical outcomes generated from completely different market environments.
People nearing retirement should take note of the fact that U.S. financial markets have entered uncharted waters now in regards to the low bond yields and high stock market valuations facing investors.
One of the most hotly contested debates in personal finance is over the safe withdrawal rate for retirement. How much can you expect to spend sustainably from your investments during retirement? What do we need to do to be safe?