Retirement Issues: How Much Should
You Withdraw Each Year?
Two questions that inevitably arise during planning sessions with our clients are: "How much can I spend during my retirement years without depleting all my assets?" and "Which accounts should I withdraw from first—IRAs, annuities, or taxable investments?" I will address each of these important questions separately.
When the retirement day finally arrives, most of our clients would like the freedom to be able to travel, continue giving to charity and children/grandchildren, and maintain a reasonable standard of living. How much of this can be funded from your retirement assets is difficult to determine, however, because you do not know how long you will live nor what type of investment returns you will earn. This creates a tension between the fear of running out of money and guilt from hoarding too much money.
Most retirement articles deal with how much money needs to be put aside for a comfortable retirement. This article looks at the other side of the question—what amount can be withdrawn each year from the assets you have accumulated at retirement. The table below shows the percentage of your portfolio's value that you can withdraw in the first year of retirement, depending on what mix of investments you hold and how long you expect to live. After the first year, you would increase your annual withdrawals by an amount equal to the inflation rate.
For example, if you retire with a portfolio valued at $600,000, made up of 60% stocks and 40% bonds, and you expect to live another 20 years, the table indicates that you can withdraw 7.4% (or $44,400) in the first year of retirement. In the second year, assuming 4% inflation, you can withdraw 4% more (or $46,176). This would continue for 20 years, after which your savings would be depleted.
There are some qualifiers you should understand in utilizing this table: (1) It does not take into account income you will receive from Social Security or pensions; (2) The annual withdrawals include any dividends or interest received by your portfolio; (3) You will have to pay taxes out of these proceeds; and (4) These withdrawal rates are based on the average twenty-year performance of the S&P 500 stock index, intermediate-term government bonds and inflation during the past half century.
As with all forecasting tables, you must be careful in how you apply it to your personal situation. Three important variables are: (1) the returns you get, (2) how long you live, and (3) the sequence in which your returns come. First, for the table to work correctly, your returns would need to equal the historical average returns of stocks and bonds. It's unlikely your experience will be precisely "average." Second, your plans could be derailed because you live longer in retirement than you expected. If you retire at 65, the mortality tables suggest you will live until age 85. With that as an average, half of all 65-year olds will live longer (including, perhaps, you!). Third, depending upon when you retire, your funds could be reduced substantially in the first few years (remember the equity returns in 2000-2002) or enhanced by higher than normal returns like we had in the late 90s. A review of Monte Carlo simulations would be a great reminder of how important this is. Also, it should be noted that the rate of inflation of a retiree's monthly living expenses is often lower than the average rate of 4%.
If you desire to err on the safe side, use a more conservative withdrawal rate. For instance, if you have a portfolio mix of 60% stocks and 40% bonds and estimate you will live another 20 years, the table suggests a 7.4% withdrawal rate the first year. You may want to assume a lower rate of return by using the 7.1% suggested for someone with a 50% stock—50% bond portfolio. Or, you could use the 6.5% rate for someone assuming a 25-year life expectancy. Naturally, your income needs will change as you move through your retirement years. You should recalculate your investment mix and withdrawal rates every few years depending on your needs and the actual investment performance of your retirement portfolio.
Next month, I'll discuss which assets—IRAs, annuities or taxable investments—you should draw from first. (Continue on to Retirement Issues: Which Assets Should You Withdraw First?) 
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