Ah retirement, one of the last major milestones in life. While exciting, deciding how to spend decades of accumulated wealth should not be taken lightly. In fact, there is a 30-year history of research solely devoted to determining a sustainable withdrawal rate. Today we will share insights on determining the withdrawal rate best suited to your retirement needs.

Origins of the Initial Safe Withdrawal Rate

It is widely agreed that Bill Bengen laid the foundation for setting a so-called safe withdrawal rate. At the time of the publication of his study, Bengen was a sole practitioner, fee-only investment advisor, and his clients were aging. Bengen saw that materials addressing his clients’ retirement questions were lacking, which led him to publish his own findings, now referred to as the 4% rule.

In a nutshell, Bengen concluded that from 1926 to 1986, an initial withdrawal rate of 4%, adjusted annually for inflation by the Consumer Price Index (CPI), would not have exhausted any portfolio before 33 years had passed, even during the worst combination of inflation and sequence of market returns. This number was much lower than the average return of a portfolio over a 30-year period, leading some investors to believe his approach was too conservative. What they forgot to consider was the sequence risk attached to a withdrawal plan of this scale. If a retiree were to withdraw the average 30-year return of the portfolio each year, they would not be leaving a margin of safety for bearish years.

Bengen outlined the assumptions built into his calculations. All hypothetical portfolios he analyzed began with a $1,000,000 initial value and consisted of 60% equities, using return data from the S&P 500, and 40% bonds, based on US 10-year Treasury bond returns. More importantly, Bengen assumed built-in annual adjustments for inflation based on the CPI to maintain fixed real spending.

In the decade following Bengen’s initial article in the Journal of Financial Planning, he conducted two more rounds of analysis, further diversifying his subject portfolios and leading to a final increase of that rate to 4.5% in 2006. Overall, it is safe to assume that a retiree can maintain a fixed real rate of spending throughout a retirement of about 30 years if they begin withdrawing from the account at a rate of 4.0%-4.5% of the portfolio value. Bengen never went on to suggest that an initial rate of 4% was the average initial rate to sustain a retiree portfolio; he simply found 4% to be the highest rate able to sustain a portfolio during the absolute worst-case scenario.

Instead of calculating how long the portfolio value remained above $0, three professors from Trinity University ran similar tests but tested the number of periods that successfully supported a full withdrawal, and they shared their findings in terms of probabilities instead of time. This study was the first to consider a retiree’s preferred confidence level. While some clients would rather eliminate all risk of running out of money, some feel comfortable taking on a little extra risk for a higher rate.

Should You Be Adjusting Your Withdrawal Rate According to the Market?

Bengen incorporated inflation adjustments, valuing predictability of income year over year. To further achieve this, he chose a withdrawal rate low enough to assure he would never have to adjust down in reaction to the market. He preferred not to adjust the rate up either, noting that the effects of an economic crash can be harder to predict than the event itself.

In his first article on the subject, he pointed out three of the worst market downturns that occurred during the observed period, the worst lasting from 1973 to 1974, when the stock market declined by about 37% and inflation was up 22%. Bengen found that clients who retired between 1966 and 1969 experienced a longer period of inflation, which drew down their portfolio excessively until the year of the crash. Because the timing of a market event that will affect your portfolio is extremely hard to predict, Bengen suggests picking an initial withdrawal rate that will be best suited to sustain your entire life according to your style. If you find your annual withdrawals are not filling your needs, adapting to a flexible-spending model would be preferred over decreasing your confidence that your portfolio will last for the intended duration.

Lifestyle Choices: Am I Willing to Make Annual Spending Adjustments in Exchange for a Higher Initial Withdrawal Rate?

Bengen called for his retired clients to set their initial rate low and increase their dollar withdrawal amount by the CPI each year. While the strategy allows for easy budgeting and a high level of confidence, many advisors have argued it is too safe. In fact, in 2023 Morningstar found that on average the portfolio value would have grown by 150% after supporting 30 years of withdrawals starting at 4% and increasing with inflation. For most, missing this kind of spending would be rather upsetting.

After years of critique aimed at Bengen and addressing these concerns, researchers Jonathan Guyton and William Klinger found a way to increase clients’ initial withdrawal rate without decreasing their confidence levels. They developed a set of decision rules to follow throughout retirement, calling for withdrawal adjustments. It is first important to note that these rules are designed to expire before the last 15 years of the planned retirement period. The first, their withdrawal rule, calls for retirees to freeze inflation adjustments in years when the return is negative and the current withdrawal rate (calculated by dividing the upcoming dollar withdrawal amount by current portfolio value) is larger than the initial withdrawal rate. They also recommend applying guardrails to the portfolio by using the capital preservation and prosperity rules. The former calls for decreasing the current withdrawal rate by 10% if it increased by 20% or more from the initial rate, while the latter calls for increasing the withdrawal rate if it declines substantially from the initial one. After running tests on portfolios with all the rules applied, they found that for a portfolio consisting of 65% equities, the new initial withdrawal rate ranged from 6.3% to 8.4%, with an average of one to three withdrawal cuts or raises depending on the client’s preferred success rate.

Retirees who want to maximize their spending and have no plans for leaving behind an estate will be best suited for the volatile nature of the average ending balance this method leaves behind.

Alternatively, a more efficient flexible-spending schedule has been developed by researchers who claim that spending during retirement does not follow the previously believed positive slope. Instead, if you were to plot a retiree’s spending levels over time, you would see the data takes more of a “smile” shape. David Blanchette, former Morningstar retirement research head, explored the consumption patterns of retirees to debunk the need for annual inflation adjustments. He found that retirees’ spending is highest in the beginning, when they can enjoy many activities at peak health. As health declines, so does spending. Eventually, in the later years, as medical bills spike, spending increases resume until the period’s end. This research suggests that maintaining a real level of spending does not align with retirees’ natural spending patterns. For retirees who would prefer to spend the most in the earlier years of retirement, Morningstar research suggests decreasing inflation adjustments by 1.9% from age 65 to 75, by 1.5% from age 75 to 85 and by 1.8% from age 85 to 95. They simulated thousands of retiree portfolios adopting this method and found a higher initial withdrawal rate, little spending variability year over year, and an average ending value that exceeded the beginning value.

Are There Any Other Considerations to Make?

Of course! When planning something as serious as retirement, there should not be any aspects of your life overlooked. To wrap up our discussion on choosing an initial safe withdrawal rate, I will point out the most relevant factors to consider after choosing your base plan. If you are leaning toward choosing a plan that incorporates fixed real spending, it is important to assess your risk tolerance. Fees and taxes pose another threat to the withdrawal rate, and the withdrawal rate should account for them.

No matter what plan you choose, it is also important to also consider your goals regarding length of retirement and estate planning. In 2001 Bengen proved that moderate decreases in the initial rate can lead to massive jumps in the ending value of the portfolio, and he concluded that a 0.2% reduction in the initial withdrawal rate leads to end values equaling or even exceeding the beginning value. Bengen also calls for a 0.5% reduction on the initial withdrawal rate if the retirement horizon is assumed to be 40 years instead of 30 years.

There is a lot to consider regarding portfolio withdrawal rates and financial, estate, and tax planning so you can enjoy a stress-free retirement. We would love to help. If you have any questions about your financial planning, please reach out to our team.

Disclaimer: This is not to be considered investment, tax, or financial advice. Please review your personal situation with your tax and/or financial advisor. Milestone Financial Planning, LLC (Milestone) is a fee-only financial planning firm and registered investment advisor in Bedford, NH. Milestone works with clients on a long-term, ongoing basis. Our fees are based on the assets that we manage and may include an annual financial planning subscription fee. Clients receive financial planning, tax planning, retirement planning, and investment management services and have unlimited access to our advisors. We receive no commissions or referral fees. We put our client’s interests first.  If you need assistance with your investments or financial planning, please reach out to one of our fee-only advisors.  Advisory services are only offered to clients or prospective clients where Milestone and its representatives are properly licensed or exempt from licensure.

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